INVESTMENT

US tax outlook: changing states?


Have you ever considered moving to another state? Could it be with better weather, lower taxes, more responsible government, or better public service?

When you’re in my birthplace Chicago, it’s hard not to. Although Illinois does not have an exclusive right to financial mismanagement or rough weather, more than its fair share.

Towards the end of 2020, many tax and residential issues are coming up that consumers may want to pay attention to and make informed decisions.

The analysis below is to help facilitate and inform that discussion. To be sure, changing states is not an easy decision, nor is the subtlety of state-to-state tax comparisons, so the following has been followed to raise awareness of some important issues rather than giving any specific investment or tax advice.


U.S. State Population Change, 2018

The four states showed the most gain and loss states
Source: United States Census Bureau

Why do people move?

The U.S. Census Bureau provides detailed information on immigration patterns within U.S. states. We tested that people use the following state-by-state proxies for each of four factors, namely, career prospects, climate, cost of living, or taxes: middle income, average annual temperature, living index, and marginal tax rate.

The top and bottom five states for our four relocation reasons are listed below:


Best and Worst: U.S. State Middle Income, 2018

Source: United States Census Bureau

Best and Worst: Average Annual Temperature, 2020


The best and the worst: the price index of living


Best and Worst: Marginal Tax Rates *

Source: Tax Foundation
* There is also no state income tax in Wyoming and South Dakota.

To understand how the four factors influence the decision to migrate, we conducted a regression analysis of the population change against each of our variables. We have theorized that people are attracted to states with improved career prospects and warmer weather and avoid states with higher cost of living and higher tax rates. As such, we expect middle incomes and weather to have a positive correlation with immigration gains, while living costs and taxes will have a negative correlation.

So what did the information reveal? Why are people moving to Idaho and Arizona and leaving New York and Alaska?


The relationship of migration with explanatory issues

Career success -0.10
Climate 0.06
Cost of living -0.38
Taxes -0.23

The three factors – weather, cost of living and tax rate – we show the expected correlation. Big surprise? There is a negative correlation between middle-income population migration. People are leaving the high-income state. Could higher income benefits in Massachusetts and other high-income states outweigh cold weather and increase taxes and living expenses?

Recent developments on the tax front

Financial deficits in many states have been well documented and the Kovid-1 pandemic epidemic has made them significantly worse. It is difficult to see how states will find a way out of this problem without raising income, property, sales or estate taxes.

At the national level, the federal government has also taken on extraordinary debt in recent years, and it is reasonable to expect that tax increases will be needed to pay it off.

Newly-elected President Joe Biden is due to take office in January with a democratic majority in the House of Representatives, but probably not in the Senate. This should inevitably delay higher taxes in the long run under the Republican administration in the future.

What kind of tax system could the future administration and Congress consider? Let’s look at Biden’s proposals.

Income tax: Maximum marginal tax rate on income above $ 400,000 increased from 37% to 39.6%.

Tax on capital gains and eligible dividends: Tax rates for those earning more than $ 1 million increase from a maximum of 20% to 39.6%.

Estate tax: Reduce the tax-free transfer limit from $ 23 million per couple to maybe $ 10 million or even $ 7 million.



How to deal with taxes

Investors have many options in the face of high or rising federal income taxes. To be sure, they can look at tax-free municipal securities, but the investment strategy in tax consideration should only be so guided. And with the deteriorating financial situation of municipalities, such securities may not be as secure as in the past. Clients may consider converting traditional theatrical IRAs into chariots so that today’s lower tax rates are off and access to the requirement of less stringent mandatory distribution of chariots among other benefits. This strategy makes it more understandable for those who expect their tax rates to remain high at the time of retirement.

It needs to be noted that the capital gains tax rate for certain clients can be almost double. Investors suspend capital gains and accelerate the harvesting of capital losses. But if higher taxes are imposed in the near future, the opposite strategy may be understandable for high-income investors. By raising long-term capital gains, investors can lock in lower taxes and defer losses, making them more valuable if taxes rise.

Estate tax is also an urgent issue for customers, including larger estates. Such clients should take advantage of the open limits before being removed.

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Should there be a tax effect where you live?

Along with income tax, some states impose estate and inheritance taxes, such taxes come on top of the federal 40% estate tax and can be up to 20% of the estate. So, say, Florida from New York can not only reduce income tax by 8.8%, but also reduce estate tax by 16%.

Of course, taxes are the only factor that applies to residential decisions. Social networks – family and friends – are critical. Such as business and income opportunities, healthcare, and crime and security considerations. And of course, local culture and the environment are also important.

Such varied criteria can be difficult to navigate, but when the decision is highly personalized, dividing issues into three parts – breaking the contract, important and less important – provides a logical framework for considering options.

Deal breakers are one or two basic requirements that must be met in order for a client to move. Think of family closeness or a minimum tax burden. On the other hand less important issues can be completely ignored. Once the criteria for breaking a contract are met, decision-making becomes one of the most important considerations of donation and acceptance. Of course, the reality is that the benefits of an estate plan do not accrue to planners like heirs, which should be kept in mind when evaluating trade-offs.

These are highly subjective decisions and smart, logical people can come to the opposite conclusion. For example, a couple may decide that their social and healthcare networks in New York are worth more than the larger property they need to move to Florida. Another will happily find a new healthcare provider in exchange for warm weather.

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An important point to consider: Meeting the state’s housing requirements can be much more complicated than staying in a state for a certain number of days. Some high tax states are their high earners and they have actually moved to another state permanently without verifying the taxes they contribute. Their tax authorities are extremely vigilant and will conduct the necessary audits to determine whether their former residents have actually been relocated.

Elvis Presley once sang “Home is where the heart is.” But for that changed state, it’s not that straightforward. For them, the home is where the tax authorities determine it!

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All posts are the author’s opinion. As such, they should not be construed as investment advice, or the opinions expressed do not necessarily reflect the views of the CFA Institute or the author’s employer.

Photo Credit: © Getty Images / Juan Silva

Gautam Dhingra, PhD, CFA

Gautam Dhingra, PhD, CFA, Founder and CEO of High Point Capital Management, LLC. He developed the firm’s leading investment approach based on the concept of franchise quality and under his leadership High Point has built an impressive investment performance record. Dhingra served as a faculty member of the Kellogg School of Management at Northwestern University for two years. In this role, he designs and teaches the Business of Investing course in the school’s MBA curriculum. His research interests include ESG investments and assessment of indomitable assets. He holds a PhD in Finance from the University of Florida at Warrington College of Business with expertise in investment and economics. In Warrington, he taught two courses in Securities Analysis and Derivatives.



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