Changes in tax laws, cost of living differences, and the appeal of milder climates prompt many people to consider relocating. While there may be benefits — including financial benefits in some cases — the process can be complex.
A person may have several residences, but he or she can only have one domicile or “legal” residence. Some elements that define a domicile include time spent in a physical location, residence, employment, real property ownership, voting registration, financial accounts, other licenses and registrations, and tax filing. Because there is no standard definition of “domicile,” the individual must maintain clear records as proof.
Changing a domicile
Clients will generally fall into two categories — those considering making a permanent move from one state to another, and those who maintain residences in multiple states and have flexibility in choosing a domicile. State laws vary. It’s critical for a client to work with a legal professional who knows specific state requirements before he or she terminates or establishes a domicile. Typically, it is easier to establish than terminate a domicile. Some considerations may involve how many days one physically spends in a state, which highlights the need for recordkeeping. To the extent the client can demonstrate a complete split from one state to another (sale of property, discontinued business dealings, etc.), a stronger case can be made for change of domicile.
Potential benefits of relocating
1. Income tax benefits. While several states do not impose any state income tax* (Arkansas, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming), the highest marginal state income tax rate in California is over 12%. It is important to note that many states will tax non-residents on compensation income earned in that state. Also, clients who have moved and changed domicile may have to file a non-resident tax return for their prior state of residence to report capital gains from selling their former primary residence. Lastly, states may differ on whether they tax other income sources such as Social Security benefits and distributions from retirement plans and IRAs.
2. Estate tax benefits. Now that the federal gift and estate tax exemption amount is over $5 million per person, many clients no longer have to plan for these taxes. However, state-based estate (and inheritance) taxes are still prevalent. In fact, over 20 states impose some sort of tax on wealth after death. For example, estates in Massachusetts may be subject to state “death” taxes if the total value of the estate exceeds $1 million.
3. Asset protection. State laws vary widely on how debtors and creditors are treated across a wide range of assets. For example, IRA assets receive creditor protection in the case of federal bankruptcy. However, outside of bankruptcy, state laws apply. While many states will provide full protection to IRA owners facing action by creditors, some states such as California may only protect IRA assets up to a level of “reasonable support.” In addition, some states have comprehensive homestead protection laws (Florida and Texas in particular) while others may protect little or no equity in a primary residence from the reach of creditors.
Here is a state-by-state guide to taxes in retirement.
Of course, there are other important considerations that will impact this decision including general cost of living expenses, other taxes such as real estate taxes, local sales taxes, and in some cases, differences in divorce laws. The option of changing domicile should be thoroughly evaluated after consultation with a qualified legal advisor.
* While New Hampshire and Tennessee do not impose income tax on wages, they do tax investment income such as capital gains and interest.