While the state in which you live may not seem to make much of a difference when you file your federal tax return, some people, including retirees and entrepreneurs, decide to move for state tax purposes.
The option to deduct state and local income taxes or sales taxes on your federal return and the amount you pay in sales tax or state income taxes may affect your overall budget.
In addition, because state and local tax dollars typically fund programs such as education, transportation, public assistance, and law enforcement, states with low or no income tax rates may raise funds through other avenues. These can include corporate tax, sales tax, or tourism taxes on hotel stays and rental cars.
Here are a few tax reasons that people decide another state may better fit their budget.
Not all state tax rates are created equal
Earlier this year, the Tax Foundation, a national independent tax policy research organization,ranked all 50 states according to the annual state and local tax burden for 2011. A tax burden is the amount of income, property, or sales tax levied on an individual or business.
According to the Tax Foundation, these are the five states with the lowest state and local tax burdens:
1. Wyoming: 6.9 percent of income
2. Alaska: 7 percent of income
3. South Dakota: 7.1 percent of income
4. Texas: 7.5 percent of income
5. Louisiana: 7.6 percent of income
At the other end of the spectrum were Northeastern states such as New York and Connecticut, which had tax burdens of 12.6 percent and 11.9 percent, respectively. California also ranked fairly high, with a tax burden of 11.4 percent of income.
Moving to a state with lower taxes
Given the spread between taxes in some states, does it ever make sense to move from a high-tax state to one with lower taxes?
Maybe. Robert Zeigen, director at CBIZ MHM, a Florida-based financial and business services provider,says it’s fairly common for an entrepreneur or hedge fund manager to relocate to Florida, which has no individual income tax and a low corporate income tax. “Any high-net-worth individual who has a lot of taxable income could certainly benefit by moving to Florida,” he says.
Florida ranked No. 31 on the Tax Foundation’s list, with residents foregoing 9.2 percent of income—higher than No. 1 ranked Wyoming, but lower than the national average of 9.8 percent.
The potential pitfall with lower taxes is that the money you don’t pay in taxes simply gets absorbed into your daily spending without a clear goal in mind. However, if you create a plan for those funds, “You can build wealth more quickly, have more disposable income to spend on vacations or cars, or save for college,” Zeigen says.
(Read more: Learn how to help avoid paying hidden taxes)
What to consider if you’re thinking about a move
Of course, tax rates aren’t the only factors to consider when moving to a lower tax state. For Zeigen, there were “non-tax-related benefits that come with moving to Florida,” such as low housing costs and warm weather.
That’s also proven true for Gary and Ivonne Richardson, retirees who moved from California to Nevada earlier this year. Before the move, Gary carefully researched the tax implications. Nevada has no income tax, and sales tax is roughly the same in both California and Nevada, so he estimates moving will save the couple approximately $8,000 in state income taxes.
Because he and his wife will no longer deduct California income tax from their federal return, Gary predicts the net savings every year will be approximately $7,400. In addition to saving on income tax, the couple says many other expenses, such as utilities and trash collection, are also cheaper in their new home.
“Tax is important for me,” he says, “but the other items are more important for Ivonne, like going from a rural area to one where everything is close and there’s more to do.”
Here’s a look at a few non-tax questions to consider before moving to a new state for the lower taxes:
What kind of lifestyle do I want and does this state offer it? This was a big one for Zeigen and for the Richardsons. “Part of the reason I moved to Florida 30 years ago was the all-year-round lifestyle for my family,” Zeigen says. “We can be outdoors playing sports all year round.” Similarly, if professional sports teams or arts and culture are important to you, then you’ll want to seek out these offerings when deciding where to move.
What are the educational opportunities in the state? If you have kids, are considering having children, or want to further your own education, research the quality of the public schools and nearby universities.
What is my earning potential in the new location? If you’re still working, find out if jobs in your chosen industry are plentiful in your new state. Even if you have a job when you move, that may change, so consider whether you’d need to relocate again or if you could find a new job locally. Also research typical salaries relative to the area’s cost of living.
Moving to a lower-tax state might seem like a great option, especially if you have a high net worth or are currently or soon-to-be retired, but there’s more to consider than your tax rate. If you have nothing to do or are far from family and friends, that low tax rate might not be enough to keep you happy.
Susan Johnston is a Boston-based freelancer who has covered personal finance for numerous publications including Bankrate.com, the Boston Globe, Learnvest.com, Mint.com, and USNews.com. Find out more at www.susan-johnston.com.