Moving to a Low-tax State Can Save a Bundle, But Document the Move

High-Tax States May Claim Moves are Bogus

If you live in a high-tax state such as New York, California or Wisconsin — or even a medium-tax state — is it time to move to a low-tax paradise like Florida or Texas? If you can make as much money in a low-tax state, the savings can add up to a small fortune over time, but before you say good riddance, crunch all the numbers.

Evaluate your income potential and cost of living in your proposed new state, not only its tax rates. Use estimates specific to your lifestyle instead of general cost-of-living metrics. Consider both one-time and recurring costs that you might incur as a result of the move.

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, 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.

It's Not Just Income Taxes

Lists of tax-friendly states invariably include the seven states that do not levy general personal income taxes. Three are warm (Florida, Nevada and Texas), and four are a tad cooler (Alaska, South Dakota, Washington and Wyoming.) Thirty-five states (plus Washington D.C.) have a graduated income tax, while eight states have a flat tax. Many states do not tax Social Security benefits; some don’t tax pension income or retirement plan distributions. New Hampshire and Tennessee tax only dividend and interest income. Cities, counties or municipalities in 14 states add their own income tax.

It’s not too hard — especially if you have tax software — to estimate your income taxes in your new state.

But that’s only a start. Comprehensive analysis must also include sales and property taxes. Sales tax rates vary, as well as what’s subject to the tax. Five states — Alaska, Delaware, Montana, New Hampshire and Oregon — do not impose statewide sales taxes, although some do permit local sales taxes.

It’s harder to compare property taxes among states since different governments calculate them differently. But the Tax Foundation found that on average, New Jersey and Illinois imposed the highest effective average property taxes, while Hawaii and Alabama had the lowest.

Fourteen states and Washington D.C. impose estate taxes; six states have inheritance taxes; but Maryland and New Jersey have both. For wealthier individuals, measuring inheritance, estate and gift taxes can be as important as evaluating the different income tax rates.

Forbes recently calculated the effective overall tax rate, including income, sales and property taxes, for a single taxpayer earning $50,000 in taxable annual income. The publication settled on Wyoming as the lowest-tax option, with Alaska, South Dakota, Texas and Louisiana rounding out the top five. These states are among the lowest for people making substantially more money too.

The least tax-friendly state? New York, according to Forbes. While the most tax-friendly state for a particular high-income taxpayer will depend on specific circumstances, New York and California are particularly unfriendly to almost everyone.

Please Release Me

To protect their revenue sources, states with high income-tax rates often take extreme measures to avoid letting their affluent residents go. 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." Document your move so that you’ll have a strong case that you’ve changed your domicile.

You’ll need to demonstrate that you have abandoned your old permanent, primary home — or domicile — in favor of establishing a domicile in your new state. Making a clean, swift and well-documented move is your best bet for avoiding a tax dispute.

Save moving receipts and dated copies of the lease or closing documents on your new home. Also, transfer your voter registration, driver’s license and vehicle registrations to your new state as soon as possible. Update your mailing address on your financial accounts and bills right away.

Notify your former state’s tax authorities of the change as soon as possible. Renounce any homestead exemption you may have claimed in your old state and claim it in your new state if possible.

If you moved for work, bringing your family with you will help establish that you intend to stay in your new home indefinitely. The same goes for bringing your pets and valuable or sentimentally important possessions. Establish ties to gyms, churches or professional organizations in your new state.

While you don’t need to do all these things to establish a new domicile, you should create a big picture that makes clear that your move is a permanent lifestyle change rather than simply an attempt to avoid paying income tax while keeping a foot in your old state.

Often you cannot sever all ties with your former state. You may have parents or adult children who remain there, or your business’s main office may need you to visit in person a certain number of days per year. These realities can mean a slightly more complicated move.

If you plan to spend significant time in your old state, keep a careful travel log with receipts, confirmations and other evidence of where you traveled and when. Most states have a threshold for determining residency status, often 183 days or more spent in a state per year. You will want to be sure you stay under that threshold in the old state and above it in the new one.

Benjamin Sullivan, EA, CFP^©, is a Certified Financial Planner and portfolio manager with Palisades Hudson Financial Group in its Austin, Texas, branch office. He recently moved from New York. Palisades Hudson (palisadeshudson.com) is a fee-only financial planning firm and investment manager based in Scarsdale, N.Y., with more than $1.1 billion under management. Branch offices are in Atlanta; Austin, Texas; Fort Lauderdale, Fla., and Portland, Oregon. Read Palisades Hudson’s daily column on personal finance, economics and other topics at http://palisadeshudson.com/current-commentary. Twitter: @palisadeshudson.