The tax overhaul signed into law in December 2017 (Tax Cuts and Jobs Act) set a $10,000 cap on state and local tax (SALT) deductions that can be taken from US federal income taxes. High-income earners who live in areas where state and local taxes are steep, such as California, New Jersey, New York and many other venues, are getting an eye-opening wake up call as they face the impact of their first tax season under the new laws.
Some residents in high SALT states have chosen to relocate to more tax-friendly parts of the country. Others have tried to relocate on paper without actually doing so—a workaround that doesn’t always bode well for the taxpayer.
High-Earners Cutting Back on SALT: State and Local Taxes
Given that many high-earning executives spend a great deal of time traveling and that they may own or lease multiple homes, accurately identifying which city and state is their official state of residence can get into interesting gray areas.
Consider this example where a dog proved he’s truly man’s best friend.
A New York executive accepted a high-profile CEO position with one of his company’s subsidiaries based in Dallas. After a period of commuting between the Big Apple and the Big D, the executive decided he like Dallas enough to rent an apartment there, lease a car in Texas and join a local gym. He filed state and federal taxes as a resident of Texas.
Two years later, the executive was promoted again, and returned to New York. The State of New York then attempted to collect two years of state taxes, nearly a half million dollars plus interest and penalties, claiming that the executive had never truly relocated to Dallas at all.
A judge however, ruled in favor of the executive based on the fact that he ultimately had relocated his elderly dog to Texas, which in the eyes of the judge made it an official move.
Rarely is the issue of where an executive spends most of his or her work time or whether the executive owns or rents residential property in the new city sufficient for determining the authenticity of the move. Many details, and not always a lot of logic, can come into play in determining whether a person has sufficiently demonstrated a change of lifestyle, such that it constitutes a true relocation. Even relocation plus retirement may not always, protect your earnings from the long arms of a state where you previously lived as a taxpayer.
Source Tax Law – Nonqualified Plans Can Help Protect Retirement Income from Taxation by Former States of Residence
Typically, an individual is subject to income taxation by the state in which he or she lives when the income is received. Some states, however, attempt to tax nonresidents on this income on the basis that it was earned, or had its source, in the first state.
Retirement income has always been a key target of this type of state taxation. Under the federal “Source Tax Law,” however, retirement income meeting certain conditions will be taxable only by the recipient’s state of residence at the time of payment, regardless of its “source”.
The Source Tax Law generally protects current nonresidents from being taxed on retirement income by states where they previously lived while employed. It covers retirement income paid from tax-favored vehicles such as tax-qualified retirement plans and IRAs. It also protects income from nonqualified deferred compensation arrangements if the income either is paid from a certain type of plan or in substantially equal periodic payments over life or life expectancy or a period of at least ten years. Thus, properly structuring deferred compensation payouts (including compliance with Internal Revenue Code § 409A may provide significant state tax savings, depending on the states involved.
To learn more about the impact of state and local taxes on retirement earnings, contact the team of executive benefits professionals at Fulcrum Partners.
Securities offered through Valmark Securities, Inc. Member FINRA, SIPC, 130 Springside Drive, Akron, OH 44333-2431, Tel: 1-800-765-5201. Investment Advisory Services offered through Valmark Advisers, Inc., which is a SEC Registered Investment Advisor. Fulcrum Partners LLC is a separate entity from Valmark Securities, Inc. and Valmark Advisers, Inc.