Out-of-State Residency Transitions: Tax Planning for Individuals and Trusts

Federal deduction limitations for state and local taxes that are paid by residents of higher tax states have prompted increased planning by those residents. Many taxpayers are looking for opportunities to shift their income to an entity, or even another state, with lower applicable tax rates, or they’re opting to transition their residency to a state with lower taxes.

Below, we outline some key tax planning considerations and strategies taxpayers can apply before transitioning residency to a new state.

Tax Considerations When Changing States

Here are some key considerations for individuals, businesses, and trusts.

Individuals

Changing state residency is a major shift involving significant work and investment. A taxpayer should give a serious thought to whether residency transition makes sense for them and if they’re willing to commit to long term living in the new state. When residency transition plans are rushed, there’s increased risk the prior state of residency will audit the taxpayer and claw back the income. There’s also risk of being unhappy in the new state if there wasn’t a well-thought-out plan to move there.

Business

It’s even more complex for a business to move between states than it is for an individual. Even if a business has moved to another state, there may be many complications that subject the business’s income to tax in the prior state, and the owner’s state of residency could also still tax income from the business. Shifting business income into a new entity, which might be subject to lower tax rates, requires an individual do the following:

  • Evaluate the business’s activities and customers to determine income sourcing
  • Determine whether moving the business activity, or a portion of the business activity, to another state can shift income to the new state
  • Create an out-of-state trust that removes income from a high tax jurisdiction

Trusts

Creating an out-of-state trust has many complexities associated with the process. Using an already established trust may make it worse. Many states look to the residency of the beneficiaries, while some states look to the residency of the fiduciaries. Others, like California, look at both. If the trust requires income to be distributed or allocated to beneficiaries, creating an out-of-state trust may not remove it from exposure to the high tax state.

State and Local Tax Planning Opportunities

In addition to exploring where you want to move and why, as well as the holistic tax impacts of the proposed change, it’s important to include an immediate state and local tax planning review.

Long-Term Implications

You should look ahead to the move’s long-term implications as they relate to your personal tax liability, quality of life, and wealth management plan.

For example, some states have a low income-tax rate but may have an aggressive estate tax or transfer tax regime. Other states may have a low tax rate but aren’t attractive in the long term, which could compromise your transition strategy. The goal is to accomplish your financial goals without sacrificing your quality of life.

Sponsored Transitions

A sponsored transition has become a more popular option that includes a business relocating its operations and headquarters or adding a second headquarters and moving a leadership team to the new location. While this used to be limited to privately held entities, more publicly traded companies are looking to provide additional flexibility to their workforce and operations which includes expanding their footprint, including relocation of high-level executives. This strategy is more complex for both the individual being moved and the business, but it can yield a number of opportunities for planning and sourcing income for the business, individuals, and any trusts holding an interest in the business.

We’re Here to Help

If you have questions about whether it makes sense to relocate your business or trust, or if you’d like assistance determining whether you should relocate, please contact your Moss Adams professional.