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The States Come Marching In: Investors Ignore State Wealth Taxes at Their Peril

As President Biden reminded taxpayers in his recent State of the Union address, the federal government continues to pursue new taxes on high-net-worth individuals. While such efforts have foundered in Congress, causing many to discount these federal proposals as political messaging with little substantive risk, a greater risk of similar initiatives becoming law on the state level may be lurking. In particular, the constitutional and political impediments to federal wealth tax proposals may not be as acute at the state level.

The Federal Landscape

During his February 7, 2023 State of the Union address, President Biden called on Congress to pass a minimum tax on “billionaires.” Presumably, more details will become available in the coming weeks when the President releases his 2024 budget framework, but the minimum tax may follow the Billionaire Minimum Income Tax Act, here, that was introduced in the House in July of 2022. That proposal imposes a 20% minimum tax on households with more than $100 million in income or more than $1 billion in “net unrealized gain” (i.e., gains from a hypothetical sale of a taxpayer’s assets for any calendar year). Other recent federal attempts to tax high-net-worth individuals include bills introduced in 2021 by Senators Ron Wyden (D-OR) and Elizabeth Warren (D-MA), respectively (here and here). As discussed here, Senator Wyden’s bill effectively requires individual taxpayers with greater than $100 million in income or $1 billion in assets to annually mark to market certain assets and recognize capital gains thereon, whereas Senator Warren’s bill imposes a 2% annual tax on the net value of all assets above $50 million and a 3% annual tax on the net value of all assets above $1 billion. To date, none of these bills has progressed beyond committee. 

Much of the impetus for these wealth tax proposals stems from the ability of high-net-worth individuals to monetize the appreciation in their assets (e.g., by borrowing at low rates against an appreciated asset) without triggering a “realization” event that would crystalize their appreciation as currently taxable income. As such, the proposals often involve some form of mark-to-market valuation to justify imposing a current tax on the unrealized “income” inherent in the appreciated assets. However, in its most naked form, a potential wealth tax may simply impose an annual tax on wealth itself, irrespective of the existence of untaxed appreciation in the assets. 

Beyond the political impediments of passing any wealth tax legislation through a divided Congress, these proposals raise thorny constitutional questions of uncertain resolution. While the deeper constitutional issues turn on whether such wealth taxes are “direct” taxes, which are subject to “apportionment” (effectively rendering such taxes unconstitutional given the practical impossibility of meeting the apportionment requirement), for mark-to-market proposals, the constitutional question may boil down to whether or not unrealized appreciation is considered “income” within the meaning of the Sixteenth Amendment. And perhaps even more specifically, whether a “realization” event is a definitional pre-requisite for income or just a rule of administrative convenience. While Congress has imposed mark-to-market regimes in narrow contexts (e.g., dealer transactions and retail futures contracts) without serious constitutional challenge, the legality of a comprehensive mark-to-market approach has long been a matter of debate within the tax bar. This constitutional uncertainty hangs over all potential federal wealth tax legislation and until resolved, Congress may not be inclined to test the limits of its taxing authority for fear that prior mark-to-market rules could be negatively impacted. While the case law in this area is sparse, a recent case in the Ninth Circuit explicitly ruled that “realization” is not a constitutional requirement. See Moore v. U.S., 36 F.4th 930 (9th Cir. 2022) linked here

If Moore is followed in other circuits, it could reduce some of the constitutional uncertainty surrounding wealth taxes and increase the odds of federal adoption if the political landscape changes in the future. However, given the political realities in Congress and the current constitutional uncertainties surrounding such legislation, a federal wealth tax appears to have little chance of passage.

The State Landscape

The need to apportion direct taxes is peculiar to the U.S. Constitution and arose from delicate compromises struck by the founders. Conversely, the ability of a state to tax its residents is typically a plenary power absent a specific limitation placed in the constitution of a particular state (e.g., the Texas Constitution has prohibited any individual income tax since 1993). As such, for most states, there may be fewer state constitutional impediments to imposing a wealth tax, although as discussed below, the Supreme Court has applied the Commerce Clause to find certain state personal income tax legislation unconstitutional. Additionally, certain states may be more inclined to adopt a wealth tax and more capable of finding the legislative consensus to do so. Indeed, currently a number of states have introduced varying tax proposals aimed at taxing high-net-worth individuals. While some of these proposals take a more conventional tack by increasing the tax rate applicable to individuals with high incomes (e.g., Massachusetts subjects taxpayers to a 4% annual tax on income earned in excess of $1 million), other states are proposing more radical approaches. Although the states are not uniform in their approaches, the various tax proposals can generally be categorized as follows.

Taxes on Net Worth (California, Washington, Hawaii)

These proposals generally impose taxes on individual taxpayers’ net worth at specific surcharges on top of other taxes paid (e.g., income tax, property tax, etc.). California is proposing a 1.5% tax on taxpayers whose net worth exceeds $1 billion, and from 2026 onwards, a 1% tax on taxpayers’ net worth in excess of $50 million but less than $1 billion. Washington is proposing a 1% tax on taxpayers’ net worth over $250 million. Hawaii is proposing a 1% tax on taxpayers’ net worth over $20 million. 

Income Taxes or Capital Gains Taxes (New York, Connecticut, Maryland, Minnesota)

These proposals either increase income taxes for high-net-worth individuals or increase taxes on capital gains. One proposal in New York, S.B. 2059, increases the income tax rate from 10.9% to 24% for income in excess of $20 million, while S.B. 2162 proposes capital gains taxes of 15% on capital gains in excess of $1 million. Two legislative proposals in Connecticut, S.B. 351 and S.B. 774, include increases to income taxes as well as surcharges on capital gains income. Maryland is proposing a 1% surcharge on capital gains. Minnesota Governor Tim Walz’s recent budget proposal calls for a 4% surcharge on capital gains and dividend income over $1 million (and a 1.5% surcharge for capital gains and dividend income less than $1 million but exceeding $500,000).  

Mark-to-Market Taxes (New York and Illinois)

These proposals require high-net-worth individuals to annually mark to market their assets and recognize capital gains thereon. The New York and Illinois legislation mirror each other and apply to residents with assets of at least $1 billion. The proposals require a taxpayer to calculate a hypothetical gain or loss at the end of its tax year on all assets and include that gain in income for the tax year up to a phase in amount. For future years, the taxpayer would again perform the calculations but would be allowed a credit for taxes paid in prior years.

Uniform Approaches and Assertion of Continued Jurisdiction

A concern for any state imposing higher taxes than its neighboring states is that the subject taxpayer will opt to relocate to a lower tax jurisdiction. This may be especially true of high-net-worth individuals who often possess both the means and freedom to relocate. Lawmakers in the aforementioned eight states have announced that they are coordinating their wealth tax efforts, see here, to make relocation less beneficial or appealing, recognizing that if these states all enact similar rules, there is less incentive to move.   

Alternatively, a state may attempt to assert continued jurisdiction upon a departing resident. This is the approach taken by California’s proposed net wealth tax discussed above. That tax would continue to apply to departing residents up to 4 years after their departure from the state (e.g., 100% the first year, 75% the second year, etc.). Effectively, California would be asserting jurisdiction to tax nonresidents based on their past connection to California.

But ... Constitutional Issues Redux?

Implementing these wealth tax approaches at the state level introduces logistical and administrative headaches (e.g., how to value illiquid assets, enforcement issues, etc.). Additionally, these proposals (especially to the extent that they allow a state to tax appreciation on assets located outside of the state or apply to nonresidents) could raise a new set of constitutional issues. For instance, these state tax proposals may implicate the Privileges and Immunities Clause (Article IV, Section 2) of the U.S. Constitution, which together with the case law thereunder generally recognizes a taxpayer’s right to travel freely among the states and prohibits discrimination against nonresidents. Additionally, under the Commerce Clause (Article I, Section 8) of the U.S. Constitution and the case law thereunder, state taxes may be unconstitutional where (1) nexus is lacking with the taxing jurisdiction, (2) the tax is not proportionate to the activities within the state, (3) the tax discriminates against interstate commerce, or (4) the tax is unrelated to services provided by the State. See Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 277-78 (1977); see also Comptroller of Treasury of Maryland v. Wynne, 575 U.S. 542 (2015) (applying the Commerce Clause and Complete Auto Transit, Inc.’s four factors to find a Maryland personal income tax provision unconstitutional). 


The allure of using various forms of wealth taxes to increase revenue at the expense of high-net-worth individuals exists at the federal level and is now spreading to state legislatures. While the likelihood of Congress enacting such measures may not be great, the risk of state legislation needs to be taken seriously. In particular, private equity and hedge funds, as well as their investors, may need to factor the impact of potential state wealth taxes into their planning and structuring.


Key Contacts

Adam Blakemore
T. +44 (0) 20 7170 8697

Linda Z. Swartz
T. +1 212 504 6062

Jon Brose
T. +1 212 504 6376

Andrew Carlon
T. +1 212 504 6378

Mark P. Howe
T. +1 202 862 2236

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