California is infamous for its tax environment, which has a layered tax structure, high tax rates, an aggressive approach to audits, and special rules for specific occasions.

The state of California has progressive income Tax rates, starting at 1% and going up to 13.3%, which is the highest in the US.

Businesses are subject to Franchise Tax, Gross Receipts Tax, and local business license Tax.

Non-resident California workers, e.g., remote workers and entertainers, are also subject to California Source Income rules.

Whether you are a resident, a business owner, an investor, or self-employed, the complexity of Tax regulations may leave you in need of professional help.

Contents of the Article

What is The California Exit Tax?

Although ‘exit tax’ isn’t an official tax listed in the state tax code, there are some tax consequences high net worth individuals and business owners have to abide by when they move out of state. Here’s how we can break it down:

1.  Taxation on California-Sourced Income

If you move out of California but still have a source of income, such as a business, entertainment, or rental income, the Franchise Tax Board (FTB) can continue to tax you.

2.  Capital Gains on transactions before the exit

You are liable to pay capital gain tax for a property you have earned and appreciated during your time as a resident of California, even if you are no longer a resident.

3.  Strict Scrutiny of Residency  

The state strictly scrutinizes citizens who claim to have changed residency, particularly high-net-worth individuals.

There are some situations where a true “Exit Tax” applies:

• Companies that leave California or switch to a different structure may be subject to deferred taxes on unrealized gains (e.g., under IRC § 367 or § 1374).
• The Exit Tax applies to some trusts or estate transfers that involve California assets.

How Does the California Exit Tax Work?

1. Residency Determination

The state of California determines if you are truly not a resident:

• When you move, you should cut all ties, including residence, bank accounts, driver’s license, voter registration, etc.
• FTB uses something called the “closest connection test” to see where your life is centered.
• Partial-year residents are taxed on income earned while in California and any California-source income.

If the FTB concludes you’re still a resident or “domiciled” in California, you’ll continue to be taxed on your worldwide income.

2. Taxation of California-Source Income

Even after you have moved, you must continue to pay tax on California-source income, which includes:

•  
• Wages earned while in California
• Rents earned from California Properties
• Royalties from California IP
• proceeds earned through sales of California real estate
• Business income related to California operations or customers

3. Capital Gains on Appreciated Assets

The concept is where it seems unfair or feels like a specific “Exit Tax”:

• If you acquire or build assets (e.g., a business, stock, real estate) while in CA and move out before selling without formally severing your ties, the state may claim rights to tax part of the capital gain.
• This is particularly true if deferred compensation, equity vesting, or IP was created while still residing in California. For Example, if you relocate to Florida in March and sell your IT firm in June, California might claim that most of the gain was created while you were a resident and tax you accordingly.

4. Business and Trust Exit Guidelines

Here’s where you can observe an actual exit tax:

• Unrealized gain under IRC § 1374 or California’s conformity rules can allow California to levy taxes on C Corporations that choose to relocate
• Trusts whose beneficiaries, grantors, or assets are tied to California will be taxed irrespective of relocation.

5. Aggressive Enforcement

Based on its Gross State Product, California is the wealthiest state in the US, making FTB infamous for:

• Specifically tracking high-income individuals and businesses after relocation
• Conducting residency audits that could last years
• Using credit card records, phone data, utility bills & even social media to prove you’re tied to the state of California

The “California Exit Tax” is not in the state code, nor is it a one-time tax. It refers to ongoing tax if:

• Income is earned in California irrespective of relocation
• The state recognizes wealth created while you were a resident &
• FTB’s determination that you haven’t truly left.

What are Some Key Triggers That Invite the California Exit Tax?

As soon as you change your residency and

1. File a non-resident or part-year return
2. Sell a large Asset or business immediately after moving
3. Continue to earn California-sourced income
4. You move without cutting ties properly

Why does the California Exit Tax, or rather the concept, exist?

Many wealthy individuals include Elon Musk, Larry Ellison, and Joe Rogan. Some of them move to low- or no -tax states like Texas, Nevada, and Florida.  The state risks losing billions in future tax revenue when high earners leave, so the effort is intended to protect the state’s tax base

Here’s our California Exit Tax Strategy – to minimize liability 

1. When Establishing a New Residency

• Renew your driver’s license and register your vehicle in your new state as well.
• Register to vote in your new state, and remember to deregister in California.
• When you buy or lease a residence in the new state, keep the relevant documentation in order.
• Move your utilities, doctors, pets, and professional licenses out of California.
• Open and operate bank accounts in the new state.

2. Stop California-Source Income

• Sell or rent out California properties only after severing ties.
• Restructure your business and ensure no income is earned from California.
• Be aware of royalties, consulting clients, or sales to customers in California.

4. File your Return

• You must file a Final Part-Year CA resident tax return for the year you move, according to Form 540NR, stating the date and reason for your move.
• Maintain proof, e.g., lease, purchase agreement, etc.

5. If You Own a Trust or Business

• Consider moving operations or changing legal entity status.
• If you are part of a Trust, remember to review:
• Location of the trustees and beneficiaries
• Where was the trust created &
• Where are the assets held

How Does a Tax Professional Help Minimize Your California Exit Tax?

A good professional ought to help you avoid penalties, interest, or retroactive taxation.

1. A CPA or outsourced accounting firm will guide you on how to legally sever ties with your California residency & structure your lifestyle and finances to pass the “Closest Connection” test conducted by the FTB.

2. Professionals can assist you in analyzing your income and restructuring it to avoid California-source designation

3. You’ll receive the right advice on avoiding “look-back” taxation on stock options, bonuses, or deferred compensation

4. An expert can help time the sale of your business, stock, or IP in such a way that California can not claim the gain was earned during your time as a resident

5. They assist in establishing non-California holding companies to retain post-move benefits

6. Redomicile your LLC or Corporation out of California

7. Benefit from expert advice on shifting trust situs and beneficiary location to avoid CA taxation

8. Prepare your final part-year or non-resident CA tax returns accurately according to Form 540NR

Conclusion: 

Taxation in California is a complex process; the exit regulation adds another layer of complexity.  Profitjets is a seasoned expert in outsourced accounting and bookkeeping, and tax services with 15+ years of experience. We can aid you by preparing accurate part-year returns and managing timing and documentation to avoid an unnecessary exit tax liability. Get in touch with us for expert guidance, CFO services, your bookkeeping needs, taxation services & your comprehensive accounting needs.

FAQs on California Exit Tax