Saving on Taxes the Hard Way
Many of my clients are high-earners who live in any one of a number of high-tax states, mostly Maryland, D.C., New York or California. It has not escaped their attention that several states have no state income tax. As we like to say in Maryland: if you can dream it, we can tax it.
If you are prepared to do the heavy lifting of changing your permanent residence it is entirely possible to do it in a very short period of time. Since most people optimize their life for other things besides state income taxes, few actually turn this idea into action.
The Dream (of paying less in taxes) is Always the Same
I have lived my entire life in the high-tax state of Maryland. Between the state and county, high earners in my county now pay a top marginal tax rate of 8.95% on all income above $250,000 (single filers) or $300,000 (married, joint filers). This is typical for high-tax states. There are also plenty of states that offer the advantage of no state income taxes at all:
- New Hampshire
have a rather modest income tax on some types of investment income, so I’ll put them on the list. We frequently have conversations with clients about relocation to these jurisdictions and the effect it would have on their income by not paying state taxes. (Note: no one has ever considered moving to Alaska to save money on taxes. If the prospect of living there just to save taxes intrigues you, please seek immediate medical attention).
We believe we will be having this conversation more frequently as the effects of the new tax laws are felt this year in to 2019. Specifically, the new law limits the deduction for state and local taxes of all kinds to $10,000 per year. Under the previous law, taxpayers could deduct all state and local taxes (income, real estate, personal property) on their 1040. For high bracketed tax payers, this savings of up to 35% or so on their federal bill was extremely valuable. True, highly technical aspects of the tax code (the alternative minimum tax -AMT- and Pease limits on deductions) often reduced the benefit, but it was still considerable. The bottom line is that the tax code offered significant relief for persons who paid high state and local taxes.
Those days are now over.
Case Study: Do You No Longer Love L.A.?
If somehow you have tired of the perfect weather and all the other benefits that come from Southern California it’s quite simple to avoid its rather nasty top tax rate of 13%: leave.
While some wealthy people do that each year, in absolute terms the actual number is shockingly low. Most estimates put the number of people who leave California solely for tax reasons each year in the low three figures. That’s right, in a state with a population of nearly 40 million people barely a handful actually leave over income taxes each year.
A Question of Domicile
It is well-settled law that a person may have multiple residences but only one domicile at any given moment. A person’s domicile is defined as “the place where a person has his/her permanent principal home.” Consider the two parts of that definition: permanent and principal.
Both criteria are evaluated on the facts and circumstances of an individual’s situation. No one fact would typically make the decision either positively or negatively as to whether you have moved your domicile from one place to another. However, several key questions arise again and again. Among them:
- Where do you spend the bulk of your time? Are you physically present in that state and, if so, for how many days of the year?
- Where do you have your principal contacts with society? E.g.: where do you vote? Where do you keep your financial accounts? Where do you have important social contacts (church, clubs, social organizations)? Where do you keep your important physical possessions (vehicles, family heirlooms, valuable property)?
- Where are the people closest to you? Does your spouse live there too? Do your minor children live there and attend school as well? For families with minor children the location of the kids is among the most important factors in determining which location a taxpayer actually considers their permanent home. Very few parents would ever intentionally separate themselves from their children for any extended period of time.
Keep in mind that if your domicile were challenged by a state income tax board the answers will likely come years after the alleged change in domicile. For example, if someone left high-tax state California for no-tax state Nevada the year she sold her company, and then moved right back the following year, chances are good she will have a hard time proving her initial move was ‘permanent’ at the time it was made.
Make your decision about where to live based on what’s best for you and yours. Gaming the system never works in the end. Like many other things, the truth shall set you free.
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