Moving from one U.S. state to another can have important tax, estate and lifestyle implications. Explore some of the key issues you should consider before choosing a new home.
In our increasingly mobile society, families may relocate within the United States for many reasons. As exciting and promising as such moves can be, they can also result in surprises for the unwary. There are many considerations—both tax and nontax related— that anyone contemplating a move should weigh before relocating. What follows is a nonexhaustive list of some of the most important considerations.
Tax, Trust and Estate Matters
Recognize that there is a significant divergence between states with little or no income tax and those with very high rates of tax on income. This difference was put into stark relief by the 2017 Tax Cuts and Jobs Act (TCJA), which limited a taxpayer's deduction for state and local taxes to $10,000 ($5,000 if married, filing separately). For high-income earners in certain states, this means that the vast majority of their state and local sales, property and income taxes could not be deducted against federally reported income from 2018 through 2025. In turn, taxpayers began to reassess the value of maintaining their residence in high-tax states. Anecdotal evidence indicates an increase in emigration from high-tax states in favor of lower-tax states.
Be aware that some states have their own state-level estate tax and others do not. California, for example, has an extremely high tax burden: an income tax rate topping out at 13.3%; property taxes of 1%-2% of the acquisition value; and sales taxes ranging between 7%-10.5%, depending on the county and municipality in which the purchase is made, among other taxes and fees. However, the one tax it does not have is any state-assessed estate, gift or inheritance tax. Thus, while California may be an expensive state within which to earn a high income, it will not impose a tax on wealth that passes at death. By contrast, Washington state has no state-level income tax. However, Washington does have one of the highest state-assessed estate taxes in the country, topping out at 20% for residents against all intangible assets (e.g., stocks, bonds, cash and partnership interests) and in-state real and tangible property.
Factor in that the new state of residence may have a much higher property tax rate. Those states that do not assess income tax typically make up revenue in other ways, including high property tax rates. Texas assesses an average property tax of approximately 1.81%, while New Hampshire (also income tax-free) assesses an average property tax of approximately 1.86%.
Be aware that states differ in how they regard community versus separate property and their differences may matter a great deal in the case of divorce. What would have been considered separate property in a non-community property state could become subject to community property treatment if the divorce occurs while residing in a community-property state (thus giving half of wealth earned during marriage to the nonearning spouse). This treatment can also affect estate planning, as one can now only control half of the community estate upon death.
Investigate what the probate process is like in the new state. In many states, probate is simple, and in some cases, there are little or no public filings with any substantive information about the size or character of the estate. A new state, which might appear attractive from an income tax standpoint, might require new estate documents to avoid an onerous and public probate process.
Might creditor protection be an issue for you? States vary widely on their treatment of creditors and debtors. Some structures that effectively guard wealth from attachment in one state may be completely ineffective, or less effective, in another.
Don’t overlook sales tax. Much like property taxes, states with little or no income tax may seek to make up “lost” revenue through higher sales taxes.
Examine the taxation of individual retirement accounts (IRAs), employee stock-option spread or retirement accounts. A taxpayer should consider whether they are subjecting these items to tax in their new state of residence, even though the wealth may have been earned as a nonresident.
Check the taxation of trusts. Some states (such as California) will tax an irrevocable non-grantor trust if any trustee or beneficiary lives there. Thus, a change of residence could subject all of the undistributed income of the trust to income tax by the state to which the trustee moves, even if the undistributed income of the trust was previously not subject to state income tax.
Consider this option: It is possible for spouses to split state residency. Thus, a high-income earner could live in a low-tax jurisdiction. If the couple files as married, filing separately, the total income of both spouses would still be subject to federal tax (with the marginal federal income tax rate of the high-income earner potentially being higher), but the state income tax would be split based on the residencies of the two spouses. In the past, the married, filing separately status would typically result in higher overall tax. However, since the passage of the TCJA and the limitation on the deductibility of state and local taxes, this may not be the case. Taxpayers should consult their tax advisor for more information and analysis.
HEALTH CARE: Evaluate the health care infrastructure of the new potential location. Smaller and more rural states may lack available, high-quality health care, thus requiring lengthy travel in order for a resident to see their doctor, a specialist or a highly rated practitioner. Also, consider elder care issues, such as the quality of assisted living and nursing facilities.
EDUCATION: The strength of school systems varies widely from one area to another, and quality schools may be relevant to those who do not have school-age children, because of the impact on property values. Explore school systems carefully.
TRAVEL AND PROXIMITY TO FAMILY: Access to travel hubs may be much farther away. Family and friends may have to connect through a hub in order to visit family members who have relocated to a tax-friendly locale. By the same token, the new resident may increase their own travel costs in order to maintain the relationships they had in their old state.
SOCIAL SETTING AND LIFESTYLE AMENITIES: The new state may not have the cultural, entertainment or culinary choices of the old state, or such offerings may be significantly different from the prior state of residence. Such quality-of-life issues can matter, and it is typically recommended that a candidate for relocation first visit the location under consideration for an extended time, if possible. The lack of access to family, friends and attractions may outweigh the tax benefit of relocation.
Relocating usually isn’t stress-free. But becoming aware of the many potential changes in your taxes, estate planning, health care and lifestyle can help eliminate surprises and make the process smoother for you and your family.
This article appears in Insights & Outcomes, a magazine from Morgan Stanley Private Wealth Management providing in-depth reports, analysis and thinking from our Firm’s leading specialists.
Please contact your Morgan Stanley Financial Advisor or Private Wealth Advisor to receive a print copy.