State taxes are worth comparison shopping, but a state with low taxes isn't always a better choice than a state with higher taxes.
Thanks to recent tax reform, the amount of state or local income tax, property tax or sales tax that taxpayers can deduct is capped at $10,000 from 2018 through 2025. This has some taxpayers in high-tax states including New York, California and Wisconsin, feeling understandably nervous."My clients have also been asking me about moving out of high tax states such as New York," says Jonathan Medows, a certified public accountant in Manhattan. "It depends on the client, [but it can mean] anywhere from 0 to 5% damage depending on income tax bracket."
Jonathan Mariner, a multi-state residency tax expert, former chief financial officer of Major League Baseball and creator of the app TaxDay notes that taxpayers can try living in the seven states in the U.S. that do not have state income tax: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. Outside of those seven exempt states, there are 11 different thresholds that determine permanent residency in the other 43 U.S. states.
That can make tax time increasingly complicated for people who own vacation homes, travel for work or split time between cities for other reasons.
"Multi-state homeowners should be aware of the regulations that define what a permanent home or abode is in their state vs. a temporary home as these definitions can vary greatly from state to state," Mariner says.
It can get complicated even if you don't move to a no-income-tax state. New Hampshire and Tennessee tax only dividend and interest income, with New Hampshire offering a $1,200 exemption for taxpayers 65 and older and Tennessee exempting taxpayers over 65 who have total annual income of up to $33,000 for single filers and $59,000 for joint filers.
If a flat income tax interests you, there's Michigan, Illinois, Colorado, Indiana, Massachusetts, North Carolina, Pennsylvania and Utah. Benjamin Sullivan, a certified financial planner and portfolio manager with Palisades Hudson Financial Group in Austin, Texas, says moving to a low-tax state can save a taxpayer a small fortune, but they'll have to base those savings on estimates specific to their lifestyle and one-time and recurring costs like moving and buying or renting a place to live.
"It's not too hard, especially if you have tax software, to estimate your income taxes in your new state," Sullivan says, while adding, "Comprehensive analysis must also include sales and property taxes."
The effective tax rate has to consider all taxes. For example, five states — Alaska, Delaware, Montana, New Hampshire and Oregon — do not impose statewide sales taxes, though some do permit local sales taxes. Retirees might also want to note that social security benefits are exempt from state income taxes in Alabama, Arizona, Arkansas, California, D.C., Delaware, Georgia, Hawaii, Idaho, Illinois, Indiana, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Mississippi, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Virginia and Wisconsin.
Some states don't tax pension income or retirement plan distributions, but cities, counties, or municipalities in 14 states add their own income tax. While the majority of states don't impose estate tax or inheritance tax, 15 states and the District of Columbia have one or the other, with two states — Maryland and New Jersey — imposing both.
"For wealthier individuals, measuring inheritance, estate and gift taxes can be as important as evaluating the different income tax rates," Sullivan says.
And don't forget about property taxes, which the Tax Foundation notes many states will apply to make up for shortcomings in other categories. While New Jersey and Illinois have the highest effective property tax rates in the country, Texas and Nebraska don't lag all that far behind. Hawaii and Alabama had the lowest effective property tax rate, but Hawaii has 12 different tax brackets for state income tax.
Fleeing from a higher-tax state to a more lenient one doesn't guarantee you'll escape your original state's taxes entirely. If you're moving for your job, you may be able to deduct some moving expenses on your federal tax return. Unless you move at the very beginning or end of the year, though, you will need to track how many days you lived in each place to determine how to handle your nonresident or part-year resident returns for the year of your move, Sullivan says. However, your old state may have a bill waiting for you at the end of your move.
"To protect their revenue sources, states with high income-tax rates often take extreme measures to avoid letting their affluent residents go," he says. "High-tax states such as New York and California have aggressively pursued residents who departed for more tax-friendly climates to the point where some critics call the process an 'exit tax.'"
State domicile law can get tricky, especially if you haven't exactly abandoned your old permanent primary home for a new one. Mariner notes that, depending on the state, spending more than 183 days (the most common), more than 270 days, or more than six months in the state establishes a domicile.
"In addition to these categorized thresholds, each state has separate rules and regulations that define how a 'day' is counted," Mariner says. Also, "whether having a permanent vs. temporary residence matters; how a tax domicile is defined; and transit days, vacation or medical days are counted."
New York, for example looks at five primary factors when determining domicile:
1. Do you have a home in New York?
2. How much time do you spend in state?
3. Do you have business connections in state?
4. Where are your valuable items (high-value paintings, wedding photos) located?
5. Do you have family connections (especially a spouse and minor children) in state?
When those can't determine domicile, the state looks at secondary criteria including where you're registered to vote and where you hold various licenses. Sullivan suggests updating your mailing address on all accounts, tranferring your drivers' license and registrations and saving moving receipts and dated copies of the lease or closing documents on your new home for just this reason.
"Residency-triggered tax audits can occur years after a specific tax return has been filed and sometimes can be triggered after the transfer of property through a sale or other transactions that might suggest a person might have a connection back to New York, for example," Mariner says.