Ken Bagner, Member in Charge of the Sobel & Co. Tax Practice, is our guest blogger today – sharing some key insights as thoughts start turning to year end tax planning!
There are several states that currently do not impose income tax on their residents. These include Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming and in Tennessee and New Hampshire, individuals pay income tax only on dividends and income from investments. Recognizing that this seems like a boon for individuals, it’s important to dig a little deeper into what this really means. First of all, these states still have budgets and still need to generate revenue to pay for parks, highways, bridges, schools and all the other state-supported institutions and programs. This is accomplished by taxing other items rather than income tax. Food, apparel and gasoline are often the first targets. In fact, Tennessee has the highest sales tax in the country and in New Hampshire homeowners pay some of the highest effective property taxes in the country according to RealtyTrac. And in Washington, the prices at the pump are typically among the nation’s highest. As you would assume, similar statistics exist for the rate of sales and property tax in other states that also do not tax income.
But if this does not discourage your move, and you are packing up to head for a no-income tax state, there are still a number of significant factors for you to consider.
The timing of your move matters
When you anticipate leaving your current residence will have an impact. For instance, if you are planning your move just before selling your business or receiving a large settlement check with the obvious reason being to avoid paying income tax on the additional income you will be generating, do not assume you can quickly get out of town to circumvent taxes owed. The amount of time you have spent in the new state, combined with substantial connections in a previous state, will raise a red flag and create suspicions about your motive for moving. You may actually have to pay some tax to the state you are exiting.
The location of your principle residence and location of your spouse and children matters
The tax authorities may not consider you a resident just because you spend time in your newly adopted state. Instead, they will examine how much time you are in your former state – and that should be less than 183 days a year to be viewed as a non-resident.
Where your vehicles are registered and where your driver’s license is issued matters
When you are making the case that you are resident of a new state, you will need to quickly change your driver’s license and car registration or your claim to residency will be deemed suspicious.
Where your doctors, dentists, accountants, attorneys and other advisors reside matters
As you seek to substantiate your residence status in a new state in order to leverage their no income tax laws, you will need to show that your consistently interacting in a meaningful way with professionals in the new state.
The reality is that anyone leaving one state for another based on a tax strategy will need to demonstrate that they have made a legitimate move and settled into a new state. This means you bank primarily in the new state, you vote there, you are a part of the religious, professional, social and civic community there and your homeowner’s property exemption or other formal documents, such as your federal income tax forms, are filed there.
Leaving a state that has high income taxes can be a smart move – and with good advice, a solid plan and a thorough approach – you can come out ahead. But you have to be aware that the states are becoming more vigilant and skeptical. The higher the stakes, the more doubtful they might be of your intentions. This mistrust results in routinely asking more questions, demanding detailed proof that you are a bona fide resident of your newly adopted state and questioning whether or not the timing of your departure is dubious.
If a move to a new state that is income tax free is on your horizon you could still be vulnerable to paying tax in the state you’ve left. Be sure to consult with your tax accountant before making any changes.