Are you looking to move to a lower income tax state in preparation for retirement? Be sure to follow these basic rules to ensure you don’t get penalized in case of an audit!
This is Robert Pagliarini. Thank you for joining me on another episode of the Pacifica Wealth Podcast. Today I’m going to talk to you about taxes – specifically, income taxes.
So, here’s the deal: I live in the state of California, and I have clients in California, but I also have clients all over the country. So, even if you do not live in California, chances are you live in a state that imposes an income tax. Well, I live in the state with the very highest income tax at 13.3%. There are many states that have double digit income taxes. So, this podcast is all about moving from a high income tax state into a lower income tax state. Why would you want to do that? Well, obviously you want to pay less in tax. So, because I live in California – and I have many clients who are in California – this is a subject that comes up quite a bit.
Often, I’ll be asked, “Listen, you know, I’m sick of paying California’s high income tax rates, or I’m sick of paying new York’s high income tax rates and I want to slow down; maybe, I’m going to retire. How can I reduce my taxes so I have more money to live on in retirement?” Well, the answer is obviously not so simple, but are there ways that you can do it? Absolutely. And that’s what I want to talk about. So, let’s just go down the list of some of the states that have what I consider very high tax rates. As I mentioned, California is at the top; we’re at 13.3%. Hawaii is at 11%. Oregon’s – and this is surprising, I think to a lot of people – but Oregon is at 9.9%. Minnesota 9.85%, Iowa almost 9%, New Jersey almost 9%. Vermont, D.C., New York are all almost at 9% income tax rates.
So, if you live in one of these states, or many of the others with what you consider high tax rates, how can you transition to a state with either lower income tax rates or – drumroll please – no income tax? So, what are those states with absolutely no personal income taxes? Well, there’s Wyoming, there’s Washington, there’s Texas, there’s Nevada, there’s Florida, there’s South Dakota and Alaska. There are a couple of other states like Tennessee and New Hampshire that are pretty tax-friendly; they don’t tax earned income, they tax interest and dividend income. But now that you have a lay of the land, your question is: how can I move to transition into a lower income tax state? If you’ve looked into this at all, chances are you got some pretty bad advice, because there is a lot of bad advice out there about how to transition from a higher income tax state into a lower income tax state.
So, let me give you just a brief example. This is a fictitious example, but I think it applies to a lot of people who are thinking about doing this. So, let’s imagine we have a couple who live in California and they’ve been diligently paying California’s very high state income tax rate for decades. They’re approaching retirement and they are thinking about buying a second house in Nevada. Why Nevada? Well, Nevada, as I mentioned earlier, has absolutely no state income tax. So, this is obviously very attractive to the California couple. So, even though they are retiring, they anticipate they’re going to be earning several hundred thousand dollars a year in interest and dividends. And also, they’re going to do some part-time consulting work. So, one of their friends tells them, “Hey, no problem. You can avoid all of California’s big bad income taxes,” which for this couple amount to about $40,000 a year, as long as they’re not in California for more than 182 days in the year.
So, this seems simple enough; a couple of months in Nevada, then a European trip, then maybe back to California for a couple of weeks, and then Nevada, etc. So, this couple even goes so far as to buy a large calendar, so they can plan their year and make sure they’re not in California for 183 days in any year. So, they’re feeling good. They’re in Nevada part of the year. They’re in California part of the year. They’re out of the country part of the year. So, everything goes really well until they get audited. And then they find out that they have to pay California tax on all of their income, even the income they earned in Nevada working as consultants. So, wait a second, what happened here? They were out of California for over six months out of the year. I mean, isn’t that the rule? Isn’t that the test that they have to abide by?
Well, the short answer is no, that’s not the test. So, here’s the deal. Each state imposes their own rules on what they determine as what they’re going to classify as a resident of their state or not. For some states, that 183 day rule that applies; in California, it doesn’t. So, here’s how California breaks it down. They consider someone a California resident if they meet either of these two criteria: criteria number one, you are present in California for other than a temporary or transitory purpose. Okay? So, if that’s you, you’re a resident of California. The second criteria is that you meet this test: you are domiciled in California, but outside California for a temporary or transitory purpose. So, let’s break both of these down.
First one is pretty easy to get, right? California says, “Listen, you’re a, you’re a resident of California if you’re in California, unless you’re just going to be here temporarily.” Maybe you’re just on sort of a work leave in California. But if you’re in California, then we’re going to count you as a resident. It doesn’t really matter how many days you’re here, but if you’re here other than for a temporary purpose, you’re a California resident. Okay, I get that probably makes sense. But the second one, this is the one that tricks a lot of people.
The second one is you are domiciled in California, but you happen to be outside of California for a temporary or transitory purpose. Well, what the heck does this mean? What this is saying is that you’re still considered a California resident, even if you’re not in California. Hmm. So, how could this be? Well, they’ve got some language on their website, on California’s Franchise Tax Board website, and it states in quotes, “Although you may have connections with another state, if you stay in California for more than a temporary or transitory purpose, you are a California resident.” So, what does this mean? It means that your income from all sources is taxable by California.
Remember that fictitious couple example I gave you above? Well, that means that any income they make as consultants – even if it’s in Nevada, maybe all their clients are in Nevada, maybe they do all their work in Nevada – it doesn’t matter. It would be subject to California state income tax.
Wow. Right? I’m only guessing what you’re thinking right now. “How is that possible?” Well, there’s two important concepts that you have to be familiar with, if you’re going to go ahead and move forward with this transition out of a higher income tax state, and into a lower income tax state. The first is domicile, and the second is residency. Both of these are really important.
According to California, domicile is defined for tax purposes as the place where you voluntarily establish yourself and your family, not merely for a special or limited purpose, but (and this is the key) with a present intention of making it your true fixed permanent home. This is the place where whenever you are absent, you will intend to return.
Let’s go back to the Nevada couple. Although the couple may have resided (meaning they are living) in Nevada, California would say that their true and permanent place of establishment remained in California. Do you notice that on the Franchise Tax Board, there’s no notice of the number of days in California versus the days out of California. Again, that’s because California doesn’t go by this 183+ day rule. It’s possible that you never even touched foot in California in a given year, but you will still be subject to California income tax. This is because domicile, as they define it, is less about the days and more about your intent. And to make matters worse for you (and this fictitious couple), the burden of intent is on you, the taxpayer. You must prove your intent if you are audited.
So, how do you go about proving your intent? Well, the maintenance of residence, basically where you live – you’re having a house, a condo or an apartment – in California, that’s a significant factor. It’s not the only factor, but it is a significant factor in establishing domicile in California. So, for the first rule, the first step is if you want to have a clean break from a high income tax state like New York, Illinois or California, you should sell your house. You should move out of your apartment. You should sell your condo. So the Franchise Tax Board in California explicitly says, “Listen, if you’re really going to leave California, you should abandon your prior domiciles.” That just means move, leave, sell, get out. So, that means physically moving and residing in a new state.
Secondly, getting back to that intent, the intent to remain in the new permanent locality is important, and it’s demonstrated by your actions. So, what does that mean? Well, what it means is if you sell your place in California or if you move out of your apartment in California, you have to pack up and you actually have to move into another state. Let’s get back to those actions. What actions can you take that would show the state you’re leaving, that you really are trying to leave and that you’re really serious about it? You don’t have one foot still in California and one foot out. To make a clean break, here are some ideas and actions that you can take.
One of them – and I talked about it briefly – is the time that you spend in California. Again, California doesn’t have a strict rule about the number of days, but here is what they do have. Basically, if you’re in California for nine months or more, whether it’s intentional or not, doesn’t matter any of your other actions. If you’re here for nine months or more, California is calling you a resident. Doesn’t matter what else you have going on. If you’re here for more than nine months, you’re a resident. So, that’s an important line in the sand. You clearly have to make sure you’re not in California for more than nine months out of the year. They also look at the location of your spouse and children.
So here’s a no-no, okay? Imagine you live in California and you are taking a temporary job in Nevada, but you don’t want to move your whole family. So, you decide, all right, no problem. I’m going to get an apartment in Nevada, but my spouse and my children are going to stay in California. They’re going to continue to go to school here, or they’re going to continue to live here. I’m going to visit them throughout the year, but I’m going to stay in Nevada, and because I was in Nevada, I’m going to pretend I was a Nevada resident. Well, the California Tax Board is going to look at that and go, “No, I don’t think so.” Your intent was never to leave California. How do we know that? Well, just look at where your spouse is living. Where are your children living? We know that you are intending to move back to California, even after your temporary work assignment is over. So, that’s something that they will look at very closely. They’ll also look at the location of your principal residence. Again, if you have a place in California and you’ve got a place somewhere else, that’s a gray area right there. If you truly want to cut the cord and make a clean break, the best thing you can do is to sell any property you have in California.
What else? Well, look at the state where you have your driver’s license. If you moved from New York or moved from California, you should probably change your license to the new state you’re living in. Also, change where your vehicles are registered. Register them in the new state where you are, where you maintain your professional licenses. Update them to your new state, where you registered to vote. Change your bank account locations to the new state or new city where you are living. Also, make sure you change doctors. Make sure your doctors are in the new state, your dentist, whoever it might be. Wherever you’re getting your healthcare provided, make sure it’s in the new state. It just shows your intent that you have no intention of keeping a foot in each state. Also, here are some other ideas. Update your place of worship. Make sure that you join a new church, if you go to a church. You can join professional associations. Maybe you join a golf club or country club, whatever you can do to show that listen, I really did intend to leave this higher income tax state and move to a lower income tax state. Make sure that it looks legitimate, because if you’re truly moving, you would do all of these things naturally, so just make sure you go about it in a smart way that your intention, although hard to prove, can be suggested by the actions that you’re taking.
What else can you do? Here are a few more ideas: there are some cool apps that you can use on your cell phone that will actually track the number of days you’re in each state. There is one called Tax Bird. There is another one called Tax Day. Yes, you could easily create an Excel spreadsheet and track your days. The cool thing about these apps though is that it does it automatically for you and potentially because it tracks your whereabouts via GPS. If you’re ever audited, it might show that you’re more serious about it than if you simply had an Excel spreadsheet. So, that’s something I would look into. I would certainly cancel your driver’s license of the state that you’re leaving. Get a new one in the state that you’re moving to. Um, silly things like, you know, getting a new library card. I know it seems trivial, but the idea here is not any single one of these is going to make or break your case. The idea is to have so many of these that if you’re audited, the auditor who’s looking at it says, “Well yeah, you know what? There’s just so much and so many actions that you took that really show your intent that you truly did want to leave.” So, get a new library card, sign up for a local newspaper delivery in your new state, vote in your new state. Again, your idea is that you want to eliminate as many ties to the state you’re leaving as possible. So, close those gym memberships, those associations that you belong to, close those local bank accounts that you have.
There you have it. If you want to leave a higher income tax date, really research the rules and the regulations in the state you currently are in, because you’ll want to use that as a playbook. You want to follow their suggestions as far as what you need to do to make a clean break. So, I hope that was helpful. If you’re thinking about leaving a high income tax date, make sure you do your research, follow some of these suggestions and do it right. You don’t want to be audited, because you could face the situation of being taxed both in the state you tried to leave and in the state you are moving into. That’s not the outcome that you want, so just do your research.
If your goal and your intent really is to leave, it can be done. There are some people who are thinking about doing this before they actually retire. And so, the advantage to that is they’re in a higher income, right? They haven’t retired yet, so they’re making more money. So, the idea of leaving is very attractive to them. They’re still making money, but they don’t want to continue to pay that high income tax rate. If that’s you, then you really need to be smart about it. I would consider working with a tax attorney or a CPA who specializes in this, because as you can see, just based on this short podcast, it’s not as simple as you might think.
If you have any questions about this or just any retirement questions, feel free to submit a question at, askdoctorrobert.com, and I will be happy to go through and answer as many of those questions as I possibly can. Thanks again for listening, and feel free to reach out with any questions. Until next time, I wish you much success in your journey to become financially independent and financially successful.