The Door Closed in January

Myron Scholes taught a generation of tax advisers that “the taxing authority is an uninvited party to all contracts.” Proposition 40 goes one better. It asks to join, ten months late, a deal that closed on January 1, 2026, and it would like 5% of everything on the table.

The story everyone knows, and the one they don’t

The public debate is about flight: which billionaires have left, who is packing, and what California loses when they go. The Legislative Analyst’s Office (LAO), whose analysis is the clearest map of this measure anyone has drawn, expects the tax to raise “tens of billions of dollars spread over several years.” It puts the possible ongoing loss of income tax from billionaires’ responses, departures included, at less than $1 billion a year.

The tax story is narrower. Residency is tested on January 1, 2026 (the “tax obligation date”), under the same rules California uses for its income tax. The measure also switches off the part-year rules. Someone who moved to Nevada in March 2026 is still taxed in full if California treated them as a resident on New Year’s Day. Leaving now does not change the bill as written; it matters only if a court moves the date. Whether someone was in fact a resident on January 1 remains a question of fact, and a fight worth having where the facts support it. For everyone else, what can still change is the number the 5% applies to and how the tax gets paid. Whether the tax survives the ballot and the courts is a separate fight.

Exhibit 1. Five dates, three of them already behind us.

Executive summary

• 5%, with a $100 million ramp. The full rate applies at $1.1 billion. Below that, the rate drops 0.1 point for each $2 million of shortfall and reaches zero at $1.0 billion.
• Inside the ramp, a 50% to 60% marginal cost. Because the rate applies to the whole amount, each extra $2 million of net worth adds $1.0 million to $1.2 million of tax.
• Private companies get a formula. Book value plus 7.5 times average book profits, times your share. The floor is any funding round or other equity sale in the past two years, unless you prove by clear and convincing evidence that it overstates value.
• Votes count as ownership. Your share is presumed to be at least your share of voting or control rights. A founder with 15% of the economics and 55% of the votes starts at 55%.
• Carry is valued as if it were equity. A 20% profits interest is presumed to be 20% of the whole entity, capital included, hurdle or no hurdle.
• Late gifts count. Property worth more than $1 million given away for less than fair value after October 15, 2025 stays in your net worth.
• Lawsuits have 60 days. A facial challenge must be filed in Sacramento within 60 days of passage, or the tax becomes “incontestable.”
• Propositions 41 and 42 could collide with it. Each of the three measures says it controls if it gets more yes votes.

01 Who owes, and on what

Exhibit 2. The measure’s main valuation rules, summarized. The statute controls.

Trusts get their own rules, and they reach far. Grantor trusts count in full. A non-grantor trust, wherever it sits, is an “applicable trust” if a living billionaire (or a related entity) has ever funded it. It is taxed on its own at 5%, with no ramp and no minimum size, unless the billionaire elects to fold it into their own return. A $10 million trust can owe tax. If several people funded the trust, only the billionaire’s proportionate share is caught. For the $1 billion test, the individual counts every non-grantor trust they have funded, in any year. For the tax itself, they add trusts funded in 2026 in full and 75% of property moved into trusts in 2025. Beneficiaries are treated as owning trust assets that can be distributed to them, unless the trust is itself an applicable trust. Expect constitutional challenges to the look-back, and watch for double counting if no election is made. “I funded that trust years ago” is not an answer. It is the start of the document request.

Relief is narrow. Alternative apportionment requires clear and convincing proof that the wealth neither built up in California nor was sustained here for 365 days in the 48 months ending December 31, 2026. It cannot cut California’s share below 25% except where a court would find the tax grossly disproportionate. A credit is allowed for wealth taxes paid to other states (a short list).

02 The founder: a $3 billion balance sheet

Take Northline’s founder, a California resident on January 1, 2026, with $3.0 billion of gross assets. The figures are invented and rounded, and we assume one class of stock.

Exhibit 3. Northline founder, net worth on the valuation date.

Suppose she pays by selling public stock in 2027, after the valuation date. Each dollar sold carries 23.8% federal tax and 13.3% California tax (the 12.3% top bracket plus the 1% Behavioral Health Services Tax) on 90 cents of gain, or 33.4 cents in all. To net $130 million she sells about $195 million of stock and pays about $65 million of income tax. In cash, the bill lands at 7.5% of her taxable net worth. Some of that income tax she would have owed on a later sale anyway; the wealth tax just moves the date.

The optional deferral account will not help her. It is open only to those whose tax exceeds all of their publicly traded assets, and her $300 million of public stock covers the bill. (For those who do qualify, the account ties up the deferred assets and taxes them on later sale or distribution; it needs its own analysis.) Her choices are to sell, borrow, or pay in five installments with a nondeductible 7.5% charge on the unpaid balance ($149.5 million in total, before any income tax on stock sold to fund it). A market-rate loan taken in 2027 may beat the installment plan, which buys time and nothing else.

03 The fund principal: carry valued as equity

For any profits interest, the measure presumes the holder owns the maximum share of profits it can earn, “without respect to whether such profits interest is subject to a condition precedent that has not yet been met.” The share is then applied to the value of the whole entity, capital included. Carry is treated as if it were equity.

Take a Harbor Partners principal who is already above $1.1 billion and holds 20% carry in Harbor Fund IV. The fund has $1 billion of book value and $80 million of average book profits. The formula gives $1.6 billion × 20%, or $320 million, and a $16 million tax. If a defensible appraisal values the carry at $60 million because the fund sits near its hurdle, the tax on that value would be $3 million. The presumption overstates the tax by $13 million, which buys a lot of appraisals. A hurdle is normally the manager’s problem. Here it becomes the appraiser’s.

Limited partners should not relax. A fund that uses investment-company accounting already carries its assets at fair value, and its book profits include unrealized gains. Adding 7.5 times those profits on top of fair value can put an LP interest well above its share of net asset value. The private equity floor adds a drafting question: it refers to “the sum of the value” of each entity the fund owns, without saying “pro rata.”

To use a lower number, the principal needs a certified appraisal and clear and convincing evidence that the formula would “substantially overstate” value. Penalties run both ways. Taxpayers face 20% and 40% penalties on large understatements, and appraisers face their own: 2% of the underpayment for substantial misstatements and 4% for gross ones. Expect appraisers to be careful and slow. Start a preliminary valuation review now, and line up the appraiser before everyone else does.

04 The threshold family: the $100 million ramp

Exhibit 4. The ramp. The rate applies to the whole amount.

Each $2 million step adds about $1.0 million of tax at the bottom of the ramp and about $1.2 million at the top. Few planning ideas survive contact with the statute. Gifts worth over $1 million made after October 15, 2025 stay in net worth, and so do 2026 transfers to trusts. A sale at fair value only swaps one asset for another. Debts reduce net worth only if they are recourse, arm’s-length, and at market rates.

Directly held real estate is excluded, so the December condo looks tempting. The measure has a general anti-avoidance rule that tests economic substance and asks whether “a substantial purpose” of a transaction was the tax benefit, and it lets the Franchise Tax Board apply step-transaction and substance-over-form doctrines. A December purchase made only to shrink the base invites that scrutiny. Real estate bought through an LLC is not excluded at all.

05 Moving versus staying

A move after January 1, 2026 does not change the Proposition 40 bill as written. The case for moving rests on future income tax. If our founder later sells Northline, with an assumed 10% basis, the $1.98 billion gain would carry about $263 million of California tax at 13.3% if she is still a resident. Whether a genuine move avoids that depends on the facts and on how the gain is sourced.

A move has to be real. In Matter of Hoff (DTA No. 850209, Oct. 9, 2025), New York’s Tax Appeals Tribunal kept a couple domiciled in New York despite a Naples condo and a signed Florida declaration of domicile, noting (quoting an older New York case) that formal declarations “have lost their importance.” Hoff is a New York case and only persuasive here. California asks whether you are domiciled in the state or present for more than a temporary or transitory purpose, and it weighs your closest connections. The Franchise Tax Board also presumes residency for anyone who spends more than nine months of a tax year in the state, though the presumption can be rebutted.

06 The fight after the vote

• At the ballot. The LAO says courts could find that Propositions 41 and 42 conflict with Proposition 40. Proposition 42 bars new taxes on owning financial assets and other personal property and limits retroactive taxes. Proposition 41 could stop the state from excluding new special-tax spending from its spending limit, which Proposition 40 does. Each measure says it controls if it gets more yes votes, and Proposition 40’s own clause may not reach the other two. Watch the yes-vote totals on all three.
• In court, fast. A facial challenge must be filed in Sacramento Superior Court within 60 days of passage, with appeal straight to the California Supreme Court. The measure asks the courts to rule by April 1, 2027 and November 1, 2027. If no one sues in time, the tax becomes “incontestable.” As-applied fights over valuation come later.
• A rewrite clause. If a court strikes either date, the measure asks it to substitute the earliest lawful date and keep the tax for 2026, or else 2027. The court will decide the remedy, but a win on the dates may only shift the tax’s timing. It is also the one scenario in which a 2026 move could matter.
• Later amendments. The Legislature may amend the measure, but only by a two-thirds vote and only in ways that further its purposes.

What we would do before December 31

• Build the January 1 residency file. Document days, homes, family, and business ties as of January 1, 2026.
• Run the formula on every private holding. Compare it to the last funding round, tender, or secondary, and to the voting presumption. As an internal screen, we flag any line where the formula exceeds a fair appraisal by more than 20%; the statute’s test is “substantially overstate,” which it does not define.
• Start valuation work now. Run a preliminary review of carry, fund interests, and private stock with thin recent profits, and engage appraisers early. The measure requires a certified appraisal for each asset over $1 million that lacks a market price.
• Model the cash. Compare a 2027 sale, the installment plan, and a market-rate loan, with income tax on any sale.
• Map every trust you have ever funded. Pre-2025 trusts are not safe; they may be taxed on their own.
• Test debts and pledges against the recourse, arm’s-length, market-rate, and October 15, 2025 rules.

What we would watch next

• November 3, 2026: yes-vote totals on Propositions 40, 41, and 42.
• Early January 2027: the 60-day window for validation suits closes.
• Within six months of passage: Franchise Tax Board forms. Rules on appraisals and abusive transactions follow, exempt from the usual rulemaking process until 2028.
• April 1 and November 1, 2027: the target dates for trial-court and Supreme Court rulings.
• October 2027: extended due date for the 2026 return.

Our take

The public argument is whether billionaires will leave. For this tax, anyone who meant to leave had to do it by New Year’s Day, and few people make that decision over holiday leftovers.

What is left is arithmetic. A 5% tax on a formula value, paid with stock sold at a 33% income tax cost, lands at 7.5% in cash for our founder. For a principal holding carry valued as equity, it can land on value that does not yet exist.

The better question is: what number will the Franchise Tax Board put on my December 31 balance sheet, and can I prove a better one? Clients who start on that in October will have time to build the evidence before December 31. The ones who start in January will have a formula.

Selected research and primary authorities

• 2026 Billionaire Tax Act, Initiative 25-0024A1 (Proposition 40), text filed with the California Attorney General, adding Rev. & Tax. Code §§50300 to 50314 (including §§50301, 50302, 50303(c), 50304, 50306, 50307, 50308, 50309, 50310, 50311, 50312, and 50314), Gov. Code §16355, Rev. & Tax. Code §17220(e), and Cal. Const. art. XIII, §37; conflicts clause at initiative Sec. 8.
• California Attorney General, Title and Summary, Initiative 25-0024A1 (Dec. 26, 2025).
• Legislative Analyst’s Office, analyses of Propositions 40, 41, and 42, November 3, 2026 ballot. The LAO’s work is careful, even-handed, and the best place to start.
• California Secretary of State, Official Voter Information Guide, November 3, 2026 (Propositions 40, 41, and 42).
• Franchise Tax Board, Publication 1031 (2025); 2025 Form 540 booklet (tax rate schedules; line 62).
• Matter of Hoff and Ocorr-Hoff, DTA No. 850209 (N.Y. Tax App. Trib. Oct. 9, 2025), quoting Wilke v. Wilke, 73 A.D.2d 915 (2d Dep’t 1980).

Important notes

Northline, Harbor Partners, and Harbor Fund IV are invented; the examples illustrate the rules and are not advice for any taxpayer. Rates assume 23.8% federal tax on long-term gain (20% plus 3.8% net investment income tax) and California’s 13.3% top rate. The installment figure assumes five equal principal payments, with the 7.5% charge on the unpaid balance from the second payment on. Section references are to the California Revenue and Taxation Code as the measure would amend it. Proposition 40 is quoted from the text filed with the California Attorney General; the text in the official voter guide controls. The measure has not been enacted, and its operation will depend on the vote, the courts, and Franchise Tax Board guidance.

This client alert is for general information only. It is not tax, legal, investment, or accounting advice. Consult your own advisers about your particular circumstances before acting on any matter discussed here. Questions: Carlos Schmidt, CPA, La Presa Partners LLC, carlos@lapresallc.com, (917) 558-6393.

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This alert is for general information only and is not tax, legal, investment, or accounting advice. Consult your own advisers before acting. Carlos A. Schmidt, MBT, MBA, CPA · carlos@lapresallc.com · (917) 558-6393.