When, and How, to Consider a Tax Domicile Change

Tax News You Can Use | For Professional Advisors

Jane G. Ditelberg, Director of Tax Planning
James Hutchens, Team Lead, Wealth Advisors

Taxes imposed by the federal government tend to receive the most press, however state and local government taxes can also be quite hefty. While some states collect income taxes, other types of state-level taxes include property taxes, sales taxes, estate or inheritance taxes and real estate transfer taxes. The types of taxes and the rates vary widely among states, and taxpayers moving to a new jurisdiction should evaluate all applicable taxes in a comprehensive manner to determine how the move will impact their overall tax bill.

The cumulative impact of state and local taxes has been felt more deeply after 2017 legislation capped deductions for these types of taxes for federal income tax purposes. Additionally, with states looking to address their own budgets, a number have enacted special “Millionaire’s Taxes¹” or “Mansion Taxes²,” essentially adding higher income tax brackets, wealth taxes or higher real estate transfer taxes for high income or wealthy taxpayers on top of the usual rates. With some state and local taxes imposing more significant burdens than ever, many taxpayers are asking themselves whether it makes sense to relocate to reduce the taxes they are or will be subject to in the future.

Whether or not these moves are motivated by tax considerations, it is important to understand what the tax burden will be in the new jurisdiction and how to establish residency.

Income Taxes

Seven states³ do not impose an individual income tax. Washington only taxes capital gains and New Hampshire taxes only interest and dividends. Ten impose a flat tax⁴, and the remainder have graduated income tax rates. In addition, 14 states have enacted legislation to lower income tax rates for 2024. The following chart documents the current state income tax rates:

The following chart lists the bottom and top income tax rates for 2024 for the 10 states with the highest state tax rates.

Note that the bracket thresholds matter. For a lower income taxpayer, taxes may be higher in Massachusetts, where the lowest bracket is 5%, than they would be in California, where the highest marginal rate is 14.4% but the lowest bracket is 1%.

It is also important to consider whether certain types of income are excluded from tax in a jurisdiction. For example, some states exclude some combination of Social Security payments, pensions, IRA and retirement plan distributions, while others do not. Depending on the taxpayer’s sources of income, this can make a bigger difference than the rates.⁵

Sales Tax

Sales taxes are imposed on the purchase of goods and sometimes services, and may be imposed by the state or any local unit of government. There are five states that do not impose a state-wide sales tax, but Oregon, Alaska and Montana have localities that impose sales tax. Delaware and New Hampshire have no sales tax at all but impose excise taxes (New Hampshire) or a gross receipts tax (Delaware) that have a similar effect.

The local (state or county) portion in some states is larger than the state rate, so it is important to consider the aggregate rate applicable. The 10 states with the highest combined average state and local sales tax rates in 2024⁶ are:

The gap between the state tax rate and the combined tax rate means there are areas in the state where the highest rates do not apply. Therefore, evaluating a move requires understanding the specific rates applicable in the local area in which the taxpayer intends to live and is likely to shop.

Estate and Inheritance Taxes

Estate and inheritance tax rates are harder to compare, in part because each state may tax different things, have different exemption amounts and have different rates. Estate taxes are imposed on what the decedent owned at death, while inheritance taxes are imposed on the recipient, and may have different rates depending upon the recipient’s relationship to the decedent. Maryland imposes both an estate tax and an inheritance tax, twelve states (including Washington D.C.) only impose an estate tax⁷ and five states only impose an inheritance tax.⁸ Hawaii and Washington have the highest marginal rates at 20%. Oregon has the lowest exclusion amount, taxing assets over $1 million, while Connecticut has the highest, matching the federal exclusion (currently at $13.61 million). This leaves 33 states imposing no inheritance or estate tax at all. This can make a significant difference in terms of what will be available to beneficiaries after death.

Property Taxes

Every state imposes real property taxes. The rates vary widely and it is important to keep in mind that home values also differ based on location. It is possible that property taxes in Hawaii, the state with the lowest tax rate, will be higher than property taxes in New Jersey, the state with the highest rate, depending on the location and value of the property. It is also important to determine whether there are any exemptions to take advantage of, such as homestead property or senior citizen status. State property tax rates are shown on the map below. Be aware that there can be additional property taxes imposed at the local level, as well, which are not included in the illustration.

Do People Relocate for Tax Purposes?

There is not a straightforward way to identify the motivation of taxpayers who move, and for most people, their motivations are likely mixed. But for some, taxes play a key role in that decision, particularly for individuals who already spend time in two or more states and can plan where to spend the majority of their time and establish tax domicile.

The federal government does track population shifts. When looking at U.S. Census Bureau data from 2020-2022, it is clear that some higher tax states (like California, New York, Louisiana, and Illinois) have lost population, while the population of some states with lower tax burdens (like Idaho, Florida, Texas and South Dakota) have increased. The variation in the states on both sides of the equation tells us this is not entirely explained by people retiring to better weather locations or moving to locations with more industry or jobs.

Whether taxes motivate a move or not, it is important to evaluate the taxes that may apply in a new location when considering a move. Comparing the applicable taxes may impact the timing of certain transactions, depending on whether the move is from a higher tax state or a lower tax state. Depending on the numbers, receiving deferred compensation, or incurring tax for a Roth IRA conversion, when residing in a low tax state may increase the benefit. Similarly, buying a more expensive home may be more feasible in a state with lower property taxes.

Considerations for Relocation

Taxes are one significant factor to consider in weighing relocation to a new state, but there are many others as well. Schools, transportation, entertainment, recreation and cultural events, available medical and elder care and proximity to family and friends need to be carefully weighed against economic factors such as taxes and the cost of living. Risks of weather or natural disasters can be a factor, as can the cost of insuring against those risks. Each family needs to balance these factors in determining whether to relocate and in selecting the destination domicile.

Steps for Establishing a New Tax Domicile

Once the decision to change a domicile has been made, there are steps to take to successfully establish tax residency in the new state. The following list is representative but not exhaustive.

• Obtain driver licenses in the new state (do not renew licenses from the old state)
• Register a vehicle in the new state
• Register to vote in the new location
• If applicable in the new state (e.g. Florida), file a Declaration of Domicile or similar document with the local court
• Review and update estate plans
• Review and update property and casualty insurance policies
• File federal tax returns using the new address
• File tax returns in the new state as a resident, and file as a non-resident in the old state if applicable
• Reference new domicile in any legal documents
• Update the mailing address for credit cards, account statements and other recurring mail
• Relocate heirlooms and collectibles to new residence
• Evaluate moving memberships, such as club memberships, library cards, houses of worship and other affiliations

If you have questions about state taxes or other issues related to relocating, please contact your Northern Trust Advisor.