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| Best Practices: Taxes |
Tax Americana
Daniel Gross
09/01/2004
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In the 1990s, Victor Riley Jr., president and chief executive of KeyCorp,
suddenly found himself adrift. When his company merged with Cleveland-based
Society for Savings in 1994, Riley sold his home in New York and moved to the
Midwest to help oversee the transition. Two years later, mission
accomplished, Riley sought to settle. “I was going to retire,” he recalls. “The
question was, where do I go?”
 The answer was close. In 1988, Riley had bought
land near Cody, Wyo., as an investment. So while many of his peers flew south to
the sunny coasts of Florida, the golf-averse Riley went west. Along with
wide-open spaces unblemished by putting greens, he quickly found the Equality
State had something else to recommend it—an attractive tax structure. Wyoming
does not have a personal income tax. “So we figured that we would be able to run
a ranch with money we would have ordinarily paid the state of New York,” Riley
recounts. And because Wyoming derives most of its income from mineral taxes, the
real estate taxes on the house Riley built on his 1,000-acre ranch, where cattle
and sheep roam, “are very acceptable.”
Over the past few decades, other
states, including Florida, Texas and Nevada, have used tax-based incentives to
attract and retain affluent residents—even as chronic budget shortfalls have
pressured many governors and legislators to raise taxes. As a result, the
variation in the way the 50 states (and even cities within those states) tax
different kinds of income has never been wider. For those of us with residences
in multiple states, the question of where to establish residency can have
large—and long-lasting—financial implications, particularly when it comes to
income tax. Nine states have no personal income tax: Alaska, Florida, Nevada,
New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming.
Conversely, avaricious states such as New York have a top tax rate of 6.85
percent (see box, below), which can quickly sap our income. (Click image to enlarge)
There is also
a range of state taxes that, if not quite hidden, is less overt—taxes on
dividends and interest, intangible property and estates. For example, Florida
imposes an intangible personal property tax levied on assets such as stocks,
bonds, mutual funds and loans. On January 1 of each year, residents must gauge
the market value of these holdings and pay a tax on them—usually $1 per every
$1,000 in value, with an exemption on the first $500,000 in assets. An
individual who owns a portfolio worth $20 million would pay $19,500. Assets such
as cash, IRAs, deferred compensation plans and employee retirement plans are
exempt from the tax. In addition, both Tennessee and New Hampshire impose
significant taxes on dividend income—6 percent and 5 percent,
respectively. (Click image to enlarge)
Traditionally, the way most states handled estate taxes
was comparatively simple: The federal government gave individuals a credit on
their return for the amount of state taxes paid. “The trend, therefore, was for
states to max out on the credit, and to couple the state tax with the federal
tax,” explains Elda Di Re, a partner at Ernst & Young in New York. “And that
made for a pretty uniform state estate tax.”
| The variation in the way the 50 states tax different kinds of income
has never been wider. |
But even that arrangement is
becoming more Byzantine. In 2001, Congress placed the federal estate tax on a
path toward complete repeal in 2010. As of 2005, the credit for state estate
taxes will disappear. The prospect of federal—and hence state—estate taxes
fading away tripped alarms in many state capitals, where budgeters had come to
rely on estate tax revenues to balance budgets. So in the past few years, many
states have decoupled their estate tax from the federal tax. Among the 16 states
that have done so, according to the Roseland, N.J.-based accounting firm
Rothstein Kass, are Kansas, Maine, Maryland, Massachusetts, Minnesota, Nebraska,
New Jersey, New York, North Carolina, Oregon, Pennsylvania, Rhode Island,
Vermont, Virginia, Washington and Wisconsin. Contrariwise, California, Florida
and Nevada now have constitutional prohibitions against an independent state
estate tax. “In 2005, someone with a $10 million estate will face over $1
million in state estate taxes in New York, whereas a person in California,
Nevada or Florida will have none,” points out Diane E. Lederman, head of wealth
planning at Neuberger Berman Trust. The trick, experts reveal, is to establish
residency in states that have lower—or nonexistent—estate taxes.
Subjective Residency
Those of us who know we are going to experience a
large liquidity event—the sale of a company or of family property, for
example—might consider relocating to a new, lower-tax domicile state before the
event. “I get people to become residents of Florida and Texas before a big
gain,” says Greg Wilder of Grant Thornton, a financial advisory firm in Orlando,
Fla.
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