States crack down on tax breaks for wealthy investors

A version of this article first appeared in CNBC’s Inside Wealth newsletter with Robert Frank, a weekly guide for wealthy investors and consumers. Register to receive future editions, straight to your inbox.

A wave of states deciding to pursue a tax incentive for investors and startup founders could prompt some wealthy residents to move, lawyers for the wealthy told Inside Wealth.

The One Big Beautiful Bill Act boosted tax breaks on qualified small business stock, better known as QSBS. However, some states, including Maine and Oregon, have targeted these tax incentives in response to reductions in federal funding.

“Tax policy has consequences, both good and bad, and I think states need to determine what makes the most sense for them,” said David Blum, partner and chair of Akerman’s national tax practice group. “Someone looking for a substantial exit might already have multiple homes.”

Blum noted that several billionaires have made high-profile departures from California as a state tax proposal for billionaires gains momentum. Google co-founder Sergey Brin, who has purchased mansions in Nevada and Florida, is funding two ballot initiatives aimed at the wealth tax measure.

The QSBS exemption, introduced during the Clinton administration, was designed to encourage investment and small business creation. The federal exclusion allows investors and founders to reduce their capital gains taxes when selling shares acquired directly from a qualifying C corporation.

To benefit from the full exemption, the stock must be held for more than five years. Prior to OBBBA, the maximum capital gains tax exemption was $10 million or 10 times the original basis of the investment, whichever was greater. The OBBBA increased the exclusion to $15 million. The bill also increased the maximum size of eligible “small businesses” from $50 million to $75 million in gross assets.

Last month, Maine and Oregon passed legislation to decouple from the federal QSBS exemption, meaning taxpayers will have to pay state income taxes on startup exits. Similar efforts in New York and Washington state failed. The District of Columbia Council voted to sever several provisions of the OBBBA, but Congress passed a resolution to block the move.

Four states already tax QSBS earnings: Alabama, Mississippi, Pennsylvania, and, most notably, California, the nation’s venture capital hub.

Proponents of QSBS reform argue that the scheme primarily benefits the wealthy. Research by the Treasury Department found that taxpayers earning more than $1 million account for nearly 75 percent of excluded earnings.

Attorney Steve Oshins told Inside Wealth that QSBS laws and other tax proposals aimed at the wealthy encourage high earners to move to other states.

The tax liability depends on where the shareholder resides at the time of selling their shares, giving clients time to plan. Oshins said it is possible in some states to use trusts to avoid income taxes on QSBS. Delaware, Nevada, and Wyoming are popular jurisdictions for establishing these trusts.

For example, he said, an Oregon resident could transfer shares to a nongrantor incomplete trust created in a state that doesn’t tax trust income, such as Nevada. As long as the trust is not administered in Oregon and none of the trustees reside there, the trust’s capital gains will not be subject to Oregon income tax.

But other states, including Maine, have stricter rules, he said. Non-grantor trusts are subject to state revenue if they are funded by or created by the will of a Maine resident, according to Oshins.

That said, the simplest solution is to move.

“Let’s say a client is about to hire me and says, ‘I have a summer house in Florida, I’m thinking of moving there,'” Oshins said. “I’ll say, ‘Let’s wait a few months. Let’s move there. Then let’s build your trust.'”

But changing homes is easier said than done, Blum said. To succeed with state tax authorities, clients must do more than change their voter registration and spend at least 183 days in another state.

“When it comes to changing residence and domicile, you really have to move and uproot your life,” he said.