Tax planning for high-net-worth clients may need to go beyond federal taxes. Some states have steep income or estate taxes or both.
California has raised income tax rates to as high 13.3% on all types of income, including dividends and capital gains; on the other coast, New York currently has a $1 million estate tax exemption, far below the $5.34 million federal threshold, so that state bite could be especially painful at the death of an HNW resident.
Moving to a less-taxing state may be rewarding but states can be aggressive when the issue of residency is in doubt. As one recent case (John Gaied, Court of Appeals of New York, February 18, 2014) revealed, New York asserted that a taxpayer owed $253,062 in New York State and City income taxes, plus interest.
The reasons: Gaied (who lived in New Jersey) had a business in New York, owned rental property nearby, allowed his parents to live in one of the units, and spent over 183 days a year in New York City. Gaied lost several rounds in lower courts, over a period of years, before the state’s highest court ruled in Gaied’s favor because he didn’t have a “residential interest” in New York.
CHANGE OF DOMICILE
Considering that states may go to great lengths to collect taxes when residency is in doubt, planners should be prepared to help clients who want to change “domicile” for tax reasons.
“I represent a couple who worked and resided in southern California,” says Brian Vosberg, who has a wealth management firm in Glendora, Calif. “They also maintained a vacation home in Hawaii. Now they’ve made Hawaii their primary residence, to minimize the amount of state taxes they have to pay.”
According to Vosberg, author of “The Complete Retiree's Guide to Social Security,” the husband has a municipal pension that runs into “multiple six figures” of income each year.
“Hawaii exempts Social Security benefits and most pension income from state income taxes,” he says. As residents of Hawaii, this couple pays much less in income tax than they would pay as Californians.
How did they make the change? “Upon retiring,” says Vosberg, “they began to use their Hawaii address on all the relevant forms: tax returns, property tax records, bills, financial statements, and so on.
Now they spend a majority of their time in Hawaii, still returning to California for ‘vacations.’” Vosberg adds that the couple’s accountant has advised them to avoid any earned income from California.
Other actions can strengthen the case that clients live in lower-tax State A, not higher-tax State B. Clients might file a “Declaration of Domicile,” generally with the appropriate County Clerk’s office. They can register to vote in the lower-tax state and cast ballots regularly. They can hire a local attorney to revise their wills—but they needn’t hire a new financial planner!