Cutting the Risk

By TOM HERMAN.- No-income-tax states such as Florida, Nevada and Texas are looking increasingly attractive to people getting ready for retirement.Some individuals want to cut their tax burden because of mounting concerns they could outlive their savings, while others simply want to keep more for themselves and their heirs. But before moving to a tax haven, it's important to pay attention to the fine print of how to move. It's easy to make seemingly minor mistakes that can trigger a painful audit -- and a hefty bill -- from the high-tax jurisdiction you thought you had left behind.
State residency rules can be complex, and audits conducted by tax officials can be highly subjective. So tax experts suggest individuals make sure their move is genuine. Some tips: Don't leave personal items such as family photos and jewelry in a part-time residence or a safe-deposit box in your former home state, and join clubs and execute a new will in your new home state.

More red flags for auditors: People with homes in more than one state, especially those with large incomes, and people who made a large sale of a partnership interest or stock in their business shortly after saying they'd moved to a low or no-tax state, warns Mark Klein, a lawyer at Hodgson Russ LLP in New York.

Lawyers and accountants say they're doing a brisk business catering to the growing numbers of high-income people seeking advice on how to relocate to low-tax places. "It's our primary source of new clients. We've made a niche business out of it," says George Ashley of Ashley Quinn, an Incline Village, Nev., CPA firm that works with many clients who move from high-tax California to Nevada, which has no state income tax.

Some relatively high-tax states are increasingly cracking down on individuals who claim to have moved out of state, but still maintain strong connections to their former homes. Massachusetts plans to hire additional tax examiners over the next few months, some of whom will be assigned to a special "domicile unit" as part of its tax-audit program. "We are confident there are a significant number of cases for us in this area," says a Massachusetts Department of Revenue spokesman.

And in New York, considered among the most aggressive states in pursuing such cases, tax officials say they have improved their techniques for targeting tax dodgers. New York state-tax revenue collections from residency audits rose to $112.9 million in fiscal 2007 from $83.4 million a year earlier, although the number of audits is down.

Of course, people who change states are still subject to federal income tax rules. State and local jurisdictions levy a variety of taxes and fees, such as sales and property taxes, which can make direct comparisons difficult. Still, state income tax rates can run as high as 10.3% in California and 8.97% in New Jersey. Besides Florida, Nevada and Texas, other states with no state income tax for individuals include Washington, Alaska, South Dakota and Wyoming. New Hampshire and Tennessee don't have a broad wage-based income tax but do tax interest and dividends. (For more on state taxes, see www.retirementliving.com/RLtaxes.html
It isn't clear how many people move exclusively or mainly for tax reasons. But from April 2000 through June 2006, there was a net migration of 2.3 million people moving from states with income taxes to states with no income taxes, an average of more than 1,000 people moving per day, says Richard Vedder, an economics professor at Ohio University in Athens, Ohio, based on an analysis of census data. He says the data, which exclude immigrant populations, don't reveal the reasons people moved.

Careful planning before moving is especially important these days because of the recent rapid spread of the alternative minimum tax, which doesn't allow certain taxpayers to deduct any state or local taxes. About four million people were caught by the AMT for 2006. Unless Congress overhauls the law in coming months, the AMT will hit more than 23 million for 2007.

For wealthy people, another key factor is that more states have begun imposing their own estate taxes. Nearly half of the states now have their own estate or inheritance taxes in addition to federal estate taxes, says Bruno Graziano at CCH, a Riverwoods, Ill., unit of Wolters Kluwer. Moreover, while the federal estate-tax exemption for an individual this year is $2 million, some states have much lower exemptions, meaning that more money may be subject to estate taxes. For example, New Jersey's estate-tax exclusion is $675,000.

Florida, long a favorite retirement spot, has no state or local individual income tax and no state estate or inheritance tax either. This year, Florida became even more appealing for many wealthy investors: It eliminated its "intangibles" tax, an annual levy imposed on the fair-market value of certain stocks and other assets. State officials said the demise of this tax would benefit an estimated 300,000 people.

Gibraltar Private Bank & Trust, a Coral Gables, Fla., unit of Boston Private Financial Holdings Inc., has put together a special booklet to help growing numbers of "Northern transplants" avoid tax headaches, says Fred Sandstrom, Gibraltar's wealth-management director. Among the tips: Use your Florida address when traveling and when corresponding with out-of-state utility and telephone companies.

New York's residency rules are complex. In general, though, if you maintain a permanent abode in the state and are in the state more than 183 days a year, you're considered a resident. Even if you're in the state less than that, you still may face a challenge because New York looks at numerous factors to gauge where your "domicile" really is, says Mr. Klein, the New York lawyer. This is a subjective test based on many factors, including your business and family ties, a comparison of your New York residence with the location you're claiming as your domicile, and where you keep "near and dear" items. That's why Mr. Klein recommends people keep near-and-dear items, such as artwork, family photos, jewelry and furs, in their non-New York home. He also recommends closing a New York safe deposit box. "It's hard to explain to auditors why your most valuable possessions are not in your home but are with you" in New York, he says.

In an audit, you need to be able to prove to skeptical tax examiners that you've really transferred your life to some new place, and auditors often demand large amounts of proof. A New York residency audit often feels like a "tax colonoscopy," says Israel Keller, a CPA and tax manager at RSM McGladrey Inc. in New York.

Mr. Keller says that in one recent case, a money manager and his wife moved from New York City to Florida. Among the items that New York state auditors have asked for are three years of diaries, appointment books or office calendars; three years of personal and business credit-card statements, and three years of phone bills for New York and their Florida residence, he says.

In your new home state, tax experts say it's important to make your move official. Register to vote, get a driver's license and register your car in the new state, and change your address on bills and important documents. Even so, establishing a legal residence in the eyes of the taxman is often based on subjective factors, including the intent of the taxpayer, which is why it's important to get advice from a tax-savvy adviser.