Moving to a Lower Tax State
Are You Thinking about Moving to a Different State? Is Your State Tax Part of Your Decision-Making?
If your intent is to relocate to a lower-tax state, it may seem like a no-brainer to move to one that has no personal income tax. No! To avoid an expensive misstep, you must consider all taxes that can potentially apply to residents — including sales taxes, property taxes and death taxes.
Low and High Tax States
States that do not have state income tax are:
- South Dakota,
- Washington and
Two other states, New Hampshire and Tennessee, tax only dividend and interest income. There are no state income taxes on wages or self-employment income. And among the states that do tax income, Pennsylvania collects the lowest income tax of 3.07%..
Meanwhile, states with highest income taxes include:
- California (13.3%),
- Hawaii (11%),
- New Jersey (10.75%),
- Oregon (9.9%),
- Minnesota (9.85%),
- District of Columbia (8.95%),
- New York (8.82%),
- Vermont (8.75%),
- Iowa (8.53), and
- Wisconsin (7.65%).
Not Just Income Taxes
The decision to move to a lower tax state isn’t as simple as just picking a state with no income tax. It is essential to consider all costs involved, which includes estate tax, sales tax, property tax, as well as annual cost of living expenses.
States without income tax still need tax money, so they get that money through other taxes, like property and sales taxes. As a general rule, states with no income tax have much higher property and sales taxes.
Property and Sales Tax Takers and Leavers
Data from the US Census Bureau’s reveals the states with the most expensive property tax are:
- New Jersey 2.49%
- Illinois 2.27%
- New Hampshire 2.18%
- Connecticut 2.14%
- Vermont 1.90%
- Wisconsin 1.85%
Meanwhile, here are states with the lowest effective real-estate property tax rates:
- Hawaii 0.28%
- Alabama 0.41%
- Colorado 0.51%
- Louisiana 0.55%
- South Carolina 0.57%
- Delaware 0.57%
You also need to know that all but four states — Oregon, New Hampshire, Montana and Delaware — rely on sales tax for revenue. And Alaska only levies a meager 1.76% sales tax rate.
According to the Tax Foundation’s 2021 findings, the five states with the highest average combined state and local sales tax rates are:
- Tennessee 9.55%
- Arkansas 9.53%
- Louisiana 9.52%
- Washington 9.23%
- Alabama 9.22%
And the residents of these states pay the least in sales taxes overall:
- Oregon 0%
- Delaware 0%
- Montana 0%
- New Hampshire 0%
- Alaska 1.76%
According to the Foundation, the top five states with the highest state and local tax combinations are:
- New York 12.7%
- Connecticut 12.6%
- New Jersey 12.2%
- Illinois 11.0%
- California and Wisconsin 11.0%
Avoid the Worst States to Die in
Some states are great to live in, but not so great to die in.
Technically, there are two “death taxes”— estate tax and inheritance tax. Estate taxes can be imposed at both the federal level and at the state level, but only states impose an inheritance tax
- Estate tax is charged against your entire taxable estate, regardless of who the beneficiaries of the estate may be.
- Inheritance tax is only charged against inheritances received by certain categories of beneficiaries.
Most people don’t have to worry about federal estate tax, which excludes up to $11.7 million for individuals and $23.4 million for married couples in 2021 (up from $11.58 million and $23.16 million, respectively, for the 2020 tax year).
For 2020, 17 states and the District of Columbia impose their own estate tax or inheritance tax. Maryland imposes both. In Maryland, the top estate tax is 16% and the exemption is $5 million. Meanwhile, inheritance tax can reach up to 10% for distant relatives and unrelated beneficiaries. Combine that with the estate tax and a single bequest can be hit by a combined 26% in death taxes.
Here are the states that collect estate and inheritance taxes:
- Washington: 20%, $2.2 million exemption
- Hawaii: 20%, $5.5 million exemption
- Vermont: 16%, $2.8 million exemption
- Minnesota: 13-16%, $3 million exemption
- Oregon: 10%-16%, $1 million exemption
- Massachusetts: 0.8%-16%, $1 million exemption
- Rhode Island: 0.8%-16%, $1.6 million exemption
- Illinois: 0.8%-16%, $4 million exemption
- New York: 3.06%-16%, $5.9 million exemption
- District of Columbia: 12%-16%, $5.8 million exemption
- Connecticut: 10%-12%, $5.1 million exemption
- Maine: 8%-12%, $5.7 million exemption
- Iowa: 0%-15%
- Kentucky: 0%-16%
- Nebraska: 1%-18%
- New Jersey: 0%-16%
- Pennsylvania: 0%-15%
So, if you have a healthy estate and move to the ‘wrong’ place, your estate could be completely exempt from any federal estate tax under the current rules but badly exposed to a significant state death tax.
Avoid Residency Audit Pitfall
If you decide to make a permanent move to a lower-tax state, make sure to establish legal residency for state tax purposes. It is important to establish a legal domicile if you want to escape taxes in the state you left. Otherwise, the old state could come after you for taxes after you’ve moved out. In the worst-case scenario, your new state could expect to get paid too.
The exact definition of legal domicile varies from state to state. In general, however, your domicile is your fixed and permanent home location and the place where you plan to return, even after periods of residing elsewhere.
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.
How to Establish a Domicile in a New State?
In recent years, states have increased residency audits as they’ve had to fight harder for revenue. Some high-tax states, such as New York, will initiate an audit depending on where you claim a new domicile.
Here are some actions that can help you establish domicile in a new state:
- Keep a log that shows how many days you spend in the old and new locations. (You should try to spend more time in the new state, if possible.)
- 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.
- Open and use bank accounts in the new state. Close accounts in the old state.
- File a resident income tax return in the new state, if it’s required. File a nonresident 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 rates to an unrelated party.
- Change the address on important documents, such as insurance policies, wills or living trusts.
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