Wealth Preservation, Multistate Problems of Relocation And Choosing a Retirement Home

By Corinne Crawford and Constance Crawford

So you want to retire. The author does a rapid review of the states with the smallest tax bite, including the hows of establishing a new residency and the knows of taxing of nonresident pensions.

The first group of baby boomers turned 50 this year. Within the next 10-20 years, the largest segment of our population will be reaching retirement age. People planning for retirement today are faced with many important issues, among them‹how to preserve wealth. State tax costs related to wealth preservation upon retirement can be very treacherous to the unwary or a boon to the well-informed prospective retiree. Specifically, states with the lowest tax rates must be identified, ways of effectively establishing residency in that new state need to be explored, and the effect of taxation on nonresident pensions weighed.

Where Should I Retire

Since the recessions of the 1990s, many states have been forced to raise taxes to balance their budgets. Further, the trend in Washington over the past few years has been to minimize Federal programs and shift more of the burden to the states. The combination of these forces has resulted in state taxes becoming a much larger burden for individuals. But there still remains a disparity among the states as to the types and level of rates of the various taxes. This presents a unique planning opportunity. Simply by moving to a new state, an individual may be able to significantly decrease his or her total tax burden.

Currently, there are seven statesÑAlaska, Florida, Nevada, South Dakota, Texas, Washington, and WyomingÑwith no state income tax on individual income. As such, these states are prime locations to be considered for retirement. The following paragraphs contain brief highlights of each of these seven states, income, sales, and death taxes.

Alaska. Alaska does not impose an individual income tax or statewide sales tax; however, in some local jurisdictions there is a sales tax levied at a rate of approximately 7%. The first $600,000 of an estate escapes taxation in Alaska when inherited by either a spouse or a child. Currently, there are no major tax hikes forecast for Alaska.

Florida. Florida has no state income tax but it does have a statewide sales tax of 6%, with some local jurisdictions adding another 1*2 to 1 %. There is also an intangible personal property tax which is divided into two categories, an annual tax and a one-time nonrecurring tax. The annual tax is levied at a rate of $2 per $1,000 of valuation and is imposed on intangibles such as stocks and bonds. The nonrecurring tax is imposed on bonds, notes, and other obligations secured by Florida real estate. The nonrecurring tax is imposed at a rate of $2 per $1,000 on the principal amount of the indebtedness and is due within 30 days of the creation of the obligation. In Florida no death taxes are levied on estates of $600,000 or less. It should be noted that there is some indication that Florida may find it necessary to increase its taxes in the near future.

Nevada. Nevada does not impose an individual state income tax; however, it has a 6.5% statewide sales tax. No death taxes are imposed on the first $600,000 of an estate in Nevada. There is a moderate possibility that Nevada may increase its taxes in the near future.

South Dakota. South Dakota does not have an individual state income tax; however, it does have a 4% statewide sales tax rate. South Dakota has no state death tax on the first $600,000 of an estate which is left to a spouse. South Dakota has no apparent plans to increase its taxes in the near future.

Texas. Texas does not have an individual state income tax; however, it does have a 6.5% statewide sales tax rate. There are no death taxes imposed on estates of $600,000 or less in Texas. Texas also has no plans to raise their taxes in the near future.

Washington. The state of Washington does not have an individual state income tax; however, it does have a 7% statewide sales tax rate. There are no death taxes imposed on estates in Washington. Washington has no plans to raise their taxes in the near future.

Wyoming. Wyoming does not have an individual state income tax; however, it does have a 4% statewide sales tax rate. There are no death taxes imposed on estates of $600,000 or less in Wyoming. Wyoming has no plans to raise its taxes in the near future.

Are There Clear Choices?

There is no one best state for retirement. When choosing a retirement state, many factors must be taken into consideration. The type of retirement income, the value of intangible assets, and the likely value of the estate upon death will weigh heavily on an individual's decision of where to retire. Also, from a state tax perspective, states imposing sales taxes vary as to taxable purchases, i.e., exemptions may be provided for clothes, drugs, etc. Additionally, as discussed below, the taxation of nonresident pension distributions is a crucial element in choosing a retirement home. The combination of these factors must be assessed on an individual basis to achieve the optimum result.

While keeping in mind the above caveats, the Exhibit showing an illustration of potential state income tax savings demonstrates the savings that may be attained by moving from a state with a high income-tax rate to a state with no income tax. A striking example is a single individual under the age 591*2 with nonannuity type pension income of $60,000 and interest of $40,000 could save $6,802 in state income taxes by moving from New York to Texas.

Establishing Residency

As important as it is to select the proper state for retirement, effectively establishing domicile or residence in the new state is also of critical importance. If domicile is not effectively established in the new state, the former state, presumably the state with the higher tax rate, may attempt to tax the individual as a resident. Nonresidents are taxed only on state source income whereas residents are taxed on all income derived from all sources. Individuals should be aware that some states define a resident to include persons who are domiciled in another state if they reside within the nondomiciliary state for a certain number of days within the year, usually, more than 183 days.

A domicile is a place where the individual has a permanent home. Domicile is determined by the intent of the individual. An individual may have many residences but only one domicile. The burden of proving domicile rests with the individual. Individuals who fail to meet this burden will be taxed as residents of their former states. The most conclusive evidence of change in domicile is the complete severing of all contacts, business or otherwise, with the previous state. An individual's continued use of a residence, continued employment, active participation in a partnership, or management of a closely held corporation in the previous state may negate the intent factor and interfere with the clear establishment of a new domicile.

Establishing a new domicile is a subjective area where the conduct and the intent of the individual are the best evidence. The following are steps that an individual may take to assist in establishing a new domicile:

* Sell the former residence.

* Buy or rent a home in the new state.

* Register to vote in the new state.

* Register automobiles and obtain driver's licenses in the new state.

* File tax returns in the new state.

* Join a house of worship in the new state.

* Join country clubs and other social and business associations in the new state.

* Open a bank account in the new state.

* Establish a mailing address in the new state.

* List the new state as domicile in wills and trust instruments.

* Limit the amount of time spent in the former state.

Consistent with undertaking each of the above activities related to the new state, these same activities should be terminated in the former state. Although none of the above listed steps in and of itself is conclusive evidence that an individual has established a new domicile, a preponderance of the factors listed above will be weighed as conclusive evidence that a new domicile has been established. Many states, most notably New York and California, are extremely aggressive in pursuing residency issues with former residents. The clear establishment of the new state as an individual's domicile is a crucial element of an effective retirement plan.

Taxation of Nonresident Pensions

The taxation of nonresident pensions presents a particularly vexing problem for state tax retirement planning. Many individuals spend their working lives in one state and their retirement years in another, usually a state with a lower tax rate. Unfortunately, upon retirement these individuals may find that their former state of residence imposes tax on the pension distributions that relate to the salary that was earned in their state.

Currently nine states‹California, Kansas, Louisiana, Massachusetts, Minnesota, New York, Oregon, Vermont, and Wisconsin--tax former residents on pension distributions. Massachusetts, Minnesota, Vermont, and Wisconsin tax nonqualified pension distributions only. California, Kansas, Louisiana, and Oregon tax both qualified and nonqualified pension distributions. New York's taxation of retirement benefits is discussed in more detail below. Nonqualified plans are plans other than those qualified under IRC Sec. 401-416. Generally, in a nonqualified plan the employer may not claim a current deduction for contributions, and the participant is not taxed until funds are distributed.

The states believe that they are entitled to the tax on the pension distributions as the income was technically earned in their state. Each state that taxes nonresident pensions has their own particular rules that must be addressed by individuals prior to retirement. With proper planning and structuring, the tax on nonresident pensions may be minimized and potentially eliminated. In states where the tax on nonresident pensions cannot be minimized, an awareness of the tax and planning for the additional cash outflow becomes equally important.

New York affords some interesting planning opportunities. In New York, pension distributions paid to nonresidents in the form of an annuity are exempt from taxation. To qualify as an annuity, the benefits of the plan must 1) be paid in cash, 2) be paid regularly, for a term of not less than half the payee's life expectancy, 3) if not paid at a uniform rate, fluctuate only in relation to the market value of the trust assets, and 4) in total be actuarially or contractually determinable on the annuity start date. In addition to the annuity exemption, New York provides an annual exclusion for up to $20,000 in pension distributions to residents and non-residents who are past the age of 59 1/2. Thus, by receiving a pension in the form of an annuity before age 59 1/2 and utilizing the annual $20,000 exclusion for other types of pension distributions after age 59 1/2, a former resident could save a substantial amount of New York tax. In contrast to New York, California provides no exclusions or exemptions from includable source income.

The taxation of nonresident pensions is a controversial area. Several states have gone back and forth on the issue. For example, Connecticut recently issued regulations that repeal the state tax on distributions from pension and retirement plans made to nonresidents. Many retirement groups are lobbying intensively to influence the Federal government to legislate against state taxation of nonresident pensions. These groups claim that the taxation of nonresident pensions is a form of taxation without representation. Over the years, several bills have been introduced in Congress to limit the states' power to tax nonresidents on qualified pension distributions.

The latest bills were introduced in the Senate in April 1994 and the House of Representatives in October 1994. The bills were passed by the Senate and the House of Representatives; however, they were not approved by the Joint Committee. The states strongly oppose any Federal restrictions on their right to tax nonresident pension distributions. Further, with the retirement of the baby boomers rapidly approaching, additional states may be tempted to impose tax on nonresident pension distributions.

The uncertainty in this area is particularly unsettling as pension distributions are a major source of retirement income. Planning in an uncertain environment can lead to unexpected results. Therefore, it is important for individuals and practitioners to stay current with the developments in this area and modify their plans as necessary.

Don't Forget the State Taxes

State taxes have become an important concern for individuals as the state tax burdens have increased significantly over the years. When planning for retirement, state taxation should be carefully scrutinized. Significant tax savings can be attained with proper state tax retirement planning. Planning in the state tax arena is particularly challenging in that the states change their rates and rules on a frequent basis. Further, state tax planning must be addressed from a multijurisdictional standpoint.

Selection of a retirement state, effectively establishing a new domicile, and planning for state taxation of nonresident pension distributions are all vital elements of a successful retirement plan. And with the likelihood of death occurring in the retirement state, local estate taxes take on significance. It should be stressed that once formulated, a multistate retirement plan must be monitored on a systematic basis to reflect all changes to state tax laws which affect the plan. *

Corinne Crawford, CPA, is with Price Waterhouse LLP. Constance Crawford, CPA, is an assistant professor at Ramapo College of New Jersey. Alaska?

SEPTEMBER 1995 / THE CPA JOURNAL

Texas?20

SEPTEMBER 1995 / THE CPA JOURNAL

Facts: Single individual under the age of 591*2 with the following income:
pension (does not qualify as an annuity) $60,000, interest $40,000.

State Income Tax Liability

New York Texas

Resident Resident

Income $100,000 $100,000

Standard deduction 6,600 0

Taxable income $93,400 $100,000

Tax $6,802* $0

*1995 Tax Rates