Is it worth relocating to trim your taxes?
Once retired, many people move to a state with low taxes or tax breaks that specifically benefit older residents. These days, people affected by tax reform’s squeeze on the federal deduction for state and local income taxes are feeling increased pressure to make such a move.
No doubt moving from a high-tax state to a low-tax state can produce savings. For instance, a taxpayer in California who pays the top state income tax rate of 13.3% can move to Florida and cut that tax rate to zero.
Yet a quick fix can be much more complicated than it seems. Yes, you’ll improve your bottom line, at least at first. But your overall tax savings may not be as great as you anticipated.
And the tug of your old hometown may cost you, too. Will you end up with higher travel expenses as you visit family? If you continue to earn an income in your old state, you’ll owe non-resident taxes, and you could be penalized if you don’t pay.
In addition, high-tax states are making it more difficult to leave, imposing tax surcharges or tax prepayments on high-end homeowners who relocate. You need to document residency in your new low-tax home state; otherwise, you could face additional taxes or penalties from your old state.
“Paying close to 10% in state taxes was bad enough when it could be deducted. Now it’s even worse,” said Lyle Benson, founder of LK Benson and Co., a Towson, Maryland CPA financial planning firm.
“But you have to be really committed to changing your domicile, and it can’t just be done for tax purposes. You really have to cut ties with your home state.”
Still, even for retirees in states with modest taxes who aren’t being hit as hard by the state and local (SALT) tax deduction cap, moving can be financially beneficial.
Things to consider
Financial planners say they’re not seeing an exodus of clients from high-tax states just yet, because the law’s impact has yet to be fully felt.
Tax laws are also subject to change. There are several bills in the U.S. House that would raise or eliminate the SALT deduction cap, though it’s unclear what action could result. Also, the cap is scheduled to expire with other provisions of the 2017 Tax Cuts and Jobs Act after 2025.
Before you load up the moving van, here is a checklist of challenges to prepare for a move to a lower-tax state.
1. A high-tax state may make it difficult to leave. In some cases, you’ll have to deal with tax prepayments or you’ll forfeit a state tax credit if you move.
Be sure to check your current state’s tax policies before considering a move, so you can be prepared for extra tax payments or extra paperwork.
2. Be willing to commit to your new state. “You can only have one domicile, and it’s where you consider your home,” Benson said. If you don’t want to spend enough time in your new location and you are reluctant to make it your home, “it’s hard to make it work from a tax standpoint,” he said.
Besides needing to prove residency in your new location, living in two places can be costly.
Let’s say you keep a house in Maryland and buy an inexpensive condo in Florida for a few months in the winter. You would rack up a lot of expenses with carrying costs on both the house and the condo, and the added travel expenses for going back and forth.
Even if you sell your house and stay in hotels, returning to your home state to visit friends and family can get expensive.
Before you move, spend time in the new location and consider whether you’ll be satisfied with the quality of healthcare and the culture and entertainment offerings. Visit outside of vacation season and stay for longer periods.
3. Be prepared to prove you really moved, particularly if you will have more than one home. Some states are particularly aggressive in making sure you cut your ties if you moved away for lower taxes but kept a second residence.
You need to show you actually took up residence elsewhere. Register to vote, open a bank account, even keep receipts from your new hairdresser.
Some high-tax states will consider you a resident if you spend more than half the year there. Be sure you understand how the rules work in both your old and new states.
4. Look at the whole tax picture. In addition to state taxes, check whether local taxes are high — and research whether taxes and other expenses are rising.
Check if the new state has death taxes, and if so, its rules. You’ll need to re-do your estate planning documents for your new state.
Also, if you are still earning income from a business based in your previous home state, you’ll need to file a nonresident tax return and pay taxes on the income.
Income from partnerships and corporations can fall into a grey area, and you’ll need to find out what you might owe, Benson said. “This does trip people up,” he said.
5. Time your move carefully. Think in the long term so you only have to move once, Benson said.
Your family members who live elsewhere are unpredictable — you could move to escape high taxes only to find you have grandchildren on the way in another state, which may lead you to move twice and spend far more than you saved.
© 2019 The Kiplinger Washington Editors, Inc. Distributed by Tribune Content Agency, LLC.