Thinking of Moving to a Lower-Tax State? Tax Angles to Consider

Thinking of Moving to a Lower-Tax State? Tax Angles to Consider

This article identifies the relevant state-tax issues for folks who are thinking about moving to a lower-tax state. Here’s what you need to know.

Consider All Applicable State and Local Taxes

If your objective is to move to a lower-tax state, it may seem like a no-brainer to move to one that has no personal income tax. But that’s not a no-brainer!

You must consider all the taxes that can potentially apply to local residents—including property taxes and death taxes.

One Case Study

Texas is “famous” for having no personal state income tax, while Colorado has a flat 4.63 percent personal state income tax rate. So, you might reasonably think it would be much cheaper taxwise to live in Texas than Colorado if you have a healthy income. Not necessarily! Here’s why.

The property tax rate on a home in some Colorado Springs locales is about 0.49 percent of the property’s actual value, as determined by the county assessor. Say you move to one of these areas and buy a $500,000 home. Your annual property tax bill would be about $2,450.

Say your taxable income is $200,000. Your Colorado state income tax bill would be $9,260. Your combined property tax bill and state income tax bill would be about $11,710 ($2,450 + $9,260).

According to the Dallas Central Appraisal District’s online property tax estimator, the annual property tax bill on a $500,000 home in some Dallas locales would be about $21,200, or about $17,800 if you’re over 65 or a surviving spouse. You would have no state income tax bill.

In most areas within both Colorado Springs and Dallas, the combined state and local sales tax rate is 8.25 percent, so no difference there.

Conclusion. So the relevant comparison for property and income taxes is $11,710 in Colorado Springs and about $21,200 (or $17,800 if you’re over 65 or a surviving spouse) in Dallas.

But if your income is really high, it could be the other way around—assuming you don’t buy a really expensive home in Dallas.

Finally, it’s important to know that the restaurants are better in Dallas. True!

Another Case Study

You like the beach. You also like the mountains. And you like low taxes. So you’re comparing the idea of moving to Marco Island, Florida, with the idea of moving to Colorado Springs. Why not? As you know, Florida is also famous for having no personal state income tax.

On Marco Island, the property tax rate is 1.0965 percent of the assessed valuation, which is usually pretty close to actual current market value. The property tax bill on a $500,000 Marco Island home would be about $5,500. You would have no state income tax bill, so the relevant number for comparison with Colorado Springs is about $5,500.

On Marco Island, the combined state and local sales tax rate is 7.0 percent, which is lower than many other jurisdictions in the U.S., including Colorado Springs.

Conclusion. Looking purely at taxes, Marco Island comes out well ahead of Colorado Springs—especially if you have a high income.

Reality check. If you want to be on the beach, $500,000 won’t get you much on Marco Island. Figure $800,000 and up. Then there are the hurricanes, which are not a factor in Colorado Springs. But the restaurants still are better on Marco Island.

Planning tip. To make the right call for you, spend some time in both places.

The Worst States to Die In

With the ultra-generous $11.58 million federal estate tax exemption for 2020 (effectively doubled if you’re married), most folks are currently free of any federal estate tax worries. Events and politics could change this happy situation, but who knows what will happen—or when?

And that’s the good news. The bad news: For 2020, 17 states plus the District of Columbia impose their own estate tax or inheritance tax. Maryland imposes both.

Exemptions from these state death taxes are way below the ultra-generous federal estate tax exemption. So, if you have a healthy estate and move to one of these states, your estate could be completely exempt from any federal estate tax hit (under the current rules) but badly exposed to a significant state death tax hit. Yikes!

What’s the difference between an estate tax and an inheritance tax? Good question.

• An estate tax is charged against your entire taxable estate, regardless of who the beneficiaries of the estate are.
• An inheritance tax is charged against only inheritances received by certain beneficiaries of your estate.

With those thoughts in mind, here’s the not-very-pretty state death picture for 2020.

Connecticut

The top estate tax rate is 12 percent. For 2020, a $5.1 million exemption is allowed. The exemption is scheduled to increase to $7.1 million for 2021 and $9.1 million for 2022 before increasing again for 2023 to match the federal exemption amount. Above $15 million, the tax rate goes to 0 percent.

Hawaii

The top estate tax rate is 20 percent. For 2020, a $5.49 million exemption is allowed.

Illinois

The top estate tax rate is 16 percent. For 2020, a $4 million exemption is allowed.

Iowa

There is no estate tax, but there is an inheritance tax. The tax rate ranges from 5 percent to 15 percent, depending on the size of the estate and the beneficiary in question. For 2020, a $25,000 exemption is allowed.

Kentucky

There is no estate tax, but there is an inheritance tax. The tax rate ranges from 4 percent to 16 percent. Members of the most common class of beneficiaries (surviving spouse, child, parent, etc.) are exempt. Tiny exemptions are allowed for members of other classes of beneficiaries.

Maine

The top estate tax rate is 12 percent. For 2020, a $5.8 million exemption is allowed.

Maryland

Maryland has both an estate tax and an inheritance tax. Ugh!

The top estate tax rate is 16 percent. For 2020, a $5 million exemption is allowed. Maryland also imposes a 10 percent inheritance tax, with the taxable amount based on how closely related the beneficiary is to you.

Massachusetts

The top estate tax rate is 16 percent. For 2020, a $1 million exemption is allowed.

Minnesota

The top estate tax rate is 16 percent. For 2020, a $3 million exemption is allowed.

Nebraska

There is no estate tax, but there is an inheritance tax. The top inheritance tax rate is 18 percent. Surviving spouses are exempt. For 2020, exemptions range from $10,000 to $40,000, depending on the relationship between you and the beneficiary.

New Jersey

There is no estate tax, but there is an inheritance tax. The top inheritance tax rate is 16 percent. Surviving spouses, parents, grandparents, and direct descendants are exempt.

New York

The top estate tax rate is 16 percent. For 2020, a $5.85 million exemption is allowed.

Oregon

The top estate tax rate is 16 percent. For 2020, a $1 million exemption is allowed.

Pennsylvania

There is no estate tax, but there is an inheritance tax. The rate ranges from 4.5 percent to 15 percent, depending on the decedent’s relationship to the beneficiary. Surviving spouses are exempt.

Rhode Island

The top estate tax rate is 16 percent. For 2020, a $1,579,922 exemption is allowed.

Vermont

The top estate tax rate is a flat 16 percent. For 2020, a $4.25 million exemption is allowed.

Washington

The top estate tax rate is 20 percent. For 2020, a $2.193 million exemption is allowed.

Washington, D.C.

The top estate tax rate is 16 percent. For 2020, a $5,762,400 exemption is allowed.

Other States Have No Death Taxes

States that are not listed above have no estate or inheritance taxes for 2020. Good for them!

Look at the Whole Tax Picture

As we said earlier, you must look at the whole tax picture before concluding that you will be moving to a state that has lower taxes for your specific situation.

For example, the state of Washington has no personal state income tax. Great! But it has an estate tax that could cost big bucks if you die there. The combined state and local sales tax rate can be as high as 10.4 percent. Not so great!

Defang the State Tax Domicile Issue

If you decide to make a permanent move to a lower-tax state, it’s important to establish legal domicile there to decouple yourself from taxes in the state you came from.

The exact definition of “legal domicile” varies from state to state.

In general, your domicile is your fixed and permanent home location and the place where you plan to return, even after periods of residing elsewhere.

Because each state has its own rules regarding your domicile, you could wind up in the worst-case scenario—with two states claiming that you owe state taxes because you established domicile in the new state but did not successfully terminate domicile in the old state.

Finally, if you die without clearly establishing domicile in just one state, both the old and new states may claim that state death taxes are owed. Not good!

Take These Steps to Establish Domicile in the New, Lower-Tax State

The more time that elapses after you change states and the more steps you take to establish domicile in the new state, the harder it is for your old state to claim that you are still domiciled there for state tax purposes. Take these steps to lock in domicile in the new state:

• If you still spend some time in the old state (perhaps for business reasons), keep a log that shows how many days you spend there (hopefully not too many) and how many days you spend at the new location (hopefully a lot more).
• Change your mailing address.
• Get a driver’s license in the new state, and register your car there.
• Register to vote in the new state. You can probably do this in conjunction with getting a driver’s license.
• Open and use bank accounts in the new state. Close accounts in the old state.
• If an income tax return is required in the new state, file a resident return. File a non-resident return or no return (whichever is appropriate) in the old state.
• Buy or lease a residence in the new state, and sell your residence in the old state or rent it out at market rate to an unrelated party.
• Change the address on passports, insurance policies, will or living trust documents, and other important documents.

Takeaways

Consider all applicable taxes before concluding that moving to another state will actually save taxes in your specific situation.

If you decide to pull up stakes, you must establish domicile in the new state to benefit from lower taxes and to avoid continued exposure to taxes in the old state.

Taking the steps explained in this article will help you establish domicile.

Last but not least, consider the distinct possibility that some states may raise taxes in response to lower tax revenue and higher spending due to the COVID-19 mess. We think this is more likely to happen in already high-tax states than in lower-tax states.

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