Key Points

• Where you reside can have a substantial impact on your financial situation, due in part to the tax cost differences between states.

• Evaluating a state’s taxes should extend beyond a simple comparison of different state tax income tax rates. The tax impact of living in a certain state is unique for all taxpayers.

• If deciding to relocate, there are important steps to take to establish residency in your new state. Prior to the move, careful planning should be done to prevent future surprises.

Assume two people make the same amount of money, own similarly valued homes, and live similar lifestyles, but one of them can save far more money than the other. What is the difference? Location, location, location. Where you live and work can make a significant difference in your ability to achieve your financial goals.

Deciding where to live involves careful thought, as there are pros and cons to living anywhere. Many of these factors can be personal or family related. On the other hand, the decision can also have a significant impact on your overall financial situation. Illinois, for example, can be a great place to live in many ways, with its fantastic school districts, good career opportunities, and rich cultural environment. On July 1, 2017, however, Illinois raised the state income tax rate from 3.75% to 4.95%¹. The state’s tax rate, combined with its second highest average property tax rate in the country², and its seventh highest average state and local sales tax rate³, can make Illinois an expensive place to live

State tax implications can often be the greatest cost variable when deciding where to live, at least from a financial perspective.

Compare state income tax rates and types

State income tax laws vary drastically and should be one of the major considerations when evaluating the financial cost of living in a particular state. There are seven states that do not tax income: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. Other states have low flat income tax rates, such as Pennsylvania (3.07%)⁴ , and Indiana (3.23%)⁵. Additionally, New Hampshire and Tennessee only tax certain investment income such as interest and dividends⁶.

Most states use a progressive income tax system similar to the federal income tax system. A progressive tax is a tax in which the tax rate increases as a taxpayer’s taxable income amount increases. Progressive tax systems add another level of complexity when comparing the impact of various state income taxes. The range between tax rates within each state’s progressive tax system can vary.

For example, Californian taxpayers can pay as little as 1% tax on income under $8,544, but as high as 13.3% on income over $1,000,000⁷. On the other hand, the lowest income tax rate for residents of North Dakota is 1.10% and only increases to a maximum rate of 2.9%⁸. Because states differ in how they tax income levels, it is vital for taxpayers to estimate their own expected income before comparing the tax costs of multiple states.

Keep in mind the type of the income you will have

Income levels and the corresponding tax rates used are only part of the story when evaluating how much a taxpayer would pay as a resident in each state. It is also important to consider the type of the income a taxpayer will have. For example, Illinois residents are not subject to tax on most retirement income sources such as Social Security, pensions, or qualified retirement plan distributions⁹. Taxpayers nearing or in retirement may be incentivized to reside in Illinois over a state like Indiana, which has lower income tax rate, but taxes retirement income.

Check on available state income tax deductions and tax credits

The tax consequences of living in a state also depend on available state income tax deductions and tax credits. Some states provide tax relief if their residents make certain investments; have charitable contributions; are more energy efficient; have childcare expenses; or pay state property taxes. In many states, taxpayers can also receive a deduction or credit for making contributions to certain education savings plans. Illinois residents can deduct up to $10,000 per year ($20,000 if Married Filing Jointly) for contributions that they make to one of the state’s sponsored 529 plans¹⁰. Not all states offer as much tax relief for these 529 contributions. California, Delaware, Hawaii, Kentucky, Maine, New Jersey, and North Carolina do not offer any sort of credit or deduction for contributions to an education savings plan¹¹.

Consider the other types of state taxes beyond income tax

State income taxes only make up a portion of the tax story in each state. While states like Texas and Florida do not have income taxes, they do have sales and property taxes. Certain states including Illinois also tax generational transfers of wealth through an estate or inheritance tax. While individuals are exempt from paying federal estate tax if their estate and prior gifts at death are less than $11,580,000 in 2020¹², exemption amounts are much lower for residents of states that have an estate tax. Illinois descendants with estates greater than $4,000,000 could pay taxes as high as 16% on assets transferred at death¹³.

See Figure 1 below, for a summary of the various tax rates across a few different states.

What does this mean for individuals?

Considering the differences in tax systems between states, it can become complicated when doing an analysis of the tax impact on your choice of state residence. The illustration below, (see Figure 2) illustrates the potential state tax burden for an individual taxpayer who earns $100,000 in wages, makes $40,000 in purchases subject to sales tax and owns a $300,000 house. This example shows the significant savings that the individual could reasonably expect as a Florida resident. It is also worth noting that while both California and Massachusetts have higher income tax rates, the total Illinois tax is highest due to the sales and property taxes implications.

The above comparison portrays Illinois as being a very costly state from a tax perspective. It is important to point out that in the example, the individual’s income is assumed to only be from wages. In contrast, if the income was primarily from Social Security, a pension, or retirement distribution, Illinois becomes a much more attractive state to reside as noted earlier. Additionally, at higher income levels, living in California will likely result in the highest state tax burden due to its steep progressive tax. In addition, homes in California tend to cost more than homes in other states which would increase the California property taxes for similar sized homes in other states.

Important things to do when making a move

If a decision has been made to change residency, whether for personal or financial reasons, following the appropriate steps to document that change will be important. Capstone has many clients who have needed to establish residency across state lines – both in and out of Illinois. A significant factor will be documenting time spent in the previous state versus the new state. In addition, some of the more common requirements to update residency include: obtaining a new driver’s license or state ID; registering to vote in the new state; updating vehicle registration; and changing utility bill payments properly. It is also often necessary for individuals or families to update estate planning documents with a licensed attorney in the new state and evaluate property, casualty, and medical insurance policies.

There are also important tax implications that arise at the time of a move that one should carefully plan for. If employed, individuals need to ensure their employers have accurate and up-to-date information on file, so they can withhold the required taxes for the appropriate state. The same holds true for those who are planning to retire or have recently retired. It is also likely that taxpayers will have to file multiple state tax returns for the year of the move. If spending time in multiple states, individuals must adhere to the state’s residency guidelines, as many states have specific rules regarding the amount of time you must spend living in that state to be considered a resident.

Deciding where to live is a big decision, and it’s important to be aware of the financial impact of the decision in addition to the potential non-financial benefits (e.g., changes in climate, location of family and friends, work location, etc.). At Capstone, we are always here to help our clients with these considerations and evaluate how these factors might impact their overall goals.

Sources

¹Illinois Dept. of Revenue http://www.revenue.state.il.us/TaxRates/Income.htm

²https://taxfoundation.org/publications/facts-and-figures/ (Table 34: Property Taxes Paid as a Percentage of Owner-Occupied Housing Value; Calendar Year 2017)

³https://taxfoundation.org/publications/facts-and-figures/ (Table 19: State & Local Sales Tax Rates; as of January 1, 2019)

⁴Bloomberg Law: Tax; 72 Pa. Stat.§ 7302

⁵Bloomberg Law: Tax; Ind. Code § 6-3-2-1 Rate of tax

⁶Bloomberg Law: Tax; New Hampshire Revised Statutes, RSA 77:1, Rate & Tennessee Code, T.C.A. § 67-2-102, Imposition, rate, and collection of tax

⁷Bloomberg Law: Tax; lndividual Income Tax Navigator, California, 3. Tax Rates

⁸Bloomberg Law: Tax; lndividual Income Tax Navigator, North Dakota, 3. Tax Rates

⁹Bloomberg Law: Tax; 35 ILCS 5/203(a)(2)(F); Illinois General Information Letter IT 01-0064-GIL (Aug. 20, 2001).

¹⁰Bloomberg Law: Tax “Illinois Compiled Statutes, 35 ILCS 5/203, Base income defined”, 7/21/19

¹¹Savingforcollege.com, “State tax deduction or credit for contributions”, 7/21/2019 https://www.savingforcollege.com/compare_529_plans/index.php?plan_question_ids%5B%5D=437&mode=Compare&plan_type_id=1&page=compare_plan_questions

¹²Form 706 Instructions https://www.irs.gov/instructions/i706

¹³2018 Important Notice Regarding Illinois Estate Tax and Fact Sheet, 07/19/2018 & www.illinoisattorneygeneral.gov/publications/calculator/2013calc/taxtable.htm

¹⁴https://www.bloomberglaw.com/product/tax/bbna/chart/2/10094/d656fe71f3a38f45bf29ba18ebd438c1

¹⁵https://taxfoundation.org/publications/facts-and-figures/ (Table 19: State & Local Sales Tax Rates; as of January 1, 2019)

¹⁶https://taxfoundation.org/publications/facts-and-figures/ (Table 34: Property Taxes Paid as a Percentage of Owner-Occupied Housing Value; Calendar Year 2017)

¹⁷https://taxfoundation.org/publications/facts-and-figures/ (Table 37: State Estate Tax Rates & Exemptions; as of January 1, 2019, & Table 38: State Inheritance Tax Rates & Exemptions; as of January 1, 2019)

¹⁸Estimated state income taxes calculated using Bloomberg’s BNA Income Tax Planner software; 7/21/19