Relocating Your Business to a No-Income Tax State: Relocating your business to a no income tax state can be a great way to save money, but there are a few things to keep in mind. In this video and in the article below, Philip Herzberg, CFP®, CDFA®, CTFA, AEP®, lead financial advisor at Team Hewins a wealth management firm, discusses relocating your business to a no-income tax state.
Article: Relocating Your Business to a State with No Income Tax
Business owners considering a sale or relocation may overlook key federal and state tax implications. Our expert tells you what you need to know about relocating your business to a no-income tax state.
By Philip Herzberg
Stepping away from your business can be an emotional time and is a pivotal transitional period, especially if you have dedicated most of your life to your company. The ultimate payoff for most successful, long-established business owners is the ability to transfer ownership of the company to their children or to sell the business and achieve financial goals. Relocating to a new state adds a twist. You will need to fully understand the tax laws of both the state where your business is located and the new state. Otherwise, you may be overlooking key considerations relating to the structure of the sale and timing of the move. You might be focused on figuring out an acceptable sale price. Yet, a more significant issue is how much you will get to keep from the sale. The most important variable is how taxes will impact the transaction. Here is what you need to consider when moving to a new state:
State Exit Taxes
Without proper planning, including knowledge of states with exit tax, you may be susceptible to mishandling the sale transaction from a tax standpoint. A state exit tax is a one-time tax that may be paid by residents, owning businesses or primary homes, who move their legal residence from a high-income tax state to a low- or no-tax state. When contemplating selling your business, you need to assess which states have an exit tax. New Jersey and California, which have very high state income taxes, are among the states that may levy an exit tax, currently or in the future. In New Jersey, the exit tax is actually a “withholding” or “estimated” tax that is paid in advance if you sell real property, such as your primary residence, and are moving out of the state. (“Will we owe the ‘exit tax’ when we sell our home?” NJMoneyHelp.com, 31 Mar.) In California, legislation has proposed to annually tax the wealthiest residents for up to ten years after leaving the state, part of the state’s wider tax on the wealthy. (Clark, Samantha. “California’s Exit Tax Explained – The Full Guide.” ThePayStubs.com. 22 August 2022)
Applying Federal and State Income Taxes to the Sale
Federal Capital Gains Tax. The sale of a business often triggers long-term federal capital gains taxes for the seller. For example, if you invested $300,000 when starting a business 15 years ago and sell it today for $10 million, your long-term capital gain is $9.7 million (the original cost basis subtracted from the selling price). A federal capital gains tax of 20%, as well as the 3.8% net investment income surtax, would apply, reducing the potential net proceeds from the sale to just below $8 million.
State income tax is also a crucial consideration. For instance, California residents could owe a state income tax of 13.3% on the same long-term capital gains. Using the example of the sale above with a capital gain of $9.7 million, the net proceeds to the seller after federal and state income taxes would be $6.1 million. Some states, such as Florida and Texas, do not have a state income tax. Conducting your sales transaction while residing in those states has obvious advantages for the seller.
Timing of Move Date and Business Sale
If you plan on selling your business in close time proximity to when you relocate, this major transaction may work against your claim that you changed residences if you are audited. The takeaway is that you should be a resident of a no-income-tax state before you proceed to sell your business. Determining your domicile, or your actual primary residence, is a question informed or grounded by your intent. Auditors may look at concrete evidence, such as a significant income transaction immediately after a claimed break in domicile, to figure out your actual intent as a seller. Be mindful that states have access to a plethora of information about you, such as your bank accounts, voting information, and car registration, that can be utilized as evidence as to whether and when you actually intended to permanently move from one state to another. The state is more likely to trigger a residency audit to the tax years surrounding the business sale transaction if there is a very large income transaction immediately after you assert that you changed residency.
Get Acquainted with Installment Sale Rules
With plans to relocate from a high-tax to a no-income-tax state, you may think that setting up the sale of a business so that the seller receives payments over time, instead of a single cash transaction completed while still in your former state of residency, will save you on income taxes under the tax laws of the new state. Even though this is how the situation works for federal taxes, states do not automatically follow this installment tax treatment of deferring state tax payments until you receive the cash. When you move out of state and accordingly stop filing taxes there, the former state will sometimes accelerate the recognition of that income, even if you have not received cash yet under the installment plan terms. These states would let you defer tax payment if you stayed in the state, but not if you stop filing after you leave. Your best approach is to file a form in your previous state promising to continue to file tax returns in that state for as long as you are receiving payments under the installment note. Even though you have not received the installment cash yet, you would be obligated to pay tax in full in advance if you don’t continue filing there. The takeaway is to be wary of whether the state where you are selling your business recognizes the deferral treatment when you move out of state. You want to avoid a situation where you decided to move to a specific no-income-tax state when you sold your business, since you assumed you would not owe taxes to your former state under the deferred payment agreement terms. This understanding may impact your decision to relocate, the timing of your move, or your utilization of the installment sale method.
Selling a Partnership Interest
If you move from a state with high income taxes to a no-income-tax state, and then sell intangible property like a license or copyright, the source of the gain for state individual income tax purposes is the state you reside in the time of sale. Conversely, if tangible property, such as land or buildings, were sold, the gains on the sale are sourced to the place the property is located at the time of sale. A possible caveat is with the sales of partnership interests. Some states consider them to be intangible sales. In effect, moving from a high-income tax rate state to one with no income tax, and subsequently selling the partnership interest, would result in no state personal income taxable of the resulting gains. Other states that tax on income have a contrasting view towards sourcing in relation to partnership sales, taking a “look-through” approach to sourcing the resulting gain. Consequently, these states would tax you on a portion of your gain from selling an interest in a partnership that operated there, even if you sold your interest after you moved away. Consult with a qualified tax advisor who is well-versed with the laws in the state where the partnership operated and where the seller lives to help you tackle any potential complexities.
Find Experienced Advisors Who Can Help
Before preparing to sell your business and possibly leaving the state that has been your historical domicile, you should speak with specialists who can help you understand the important financial and tax implications, including State and Local Tax (SALT) ramifications. They can empower you to set up a plan that maximizes your financial benefits and minimizes income tax consequences, while enabling you to relocate to a desirable state with no income tax. Rest assured, you can begin your next chapter of life with confidence and peace of mind.
Watch this video to learn the issues related to relocating your business to a no-income tax state. To see more videos on finStream featuring Philip Herzberg, please click this link: https://www.finstream.tv/featured/philip-herzberg/
About the author: Philip Hertzberg
Philip Herzberg, CFP®, CDFA®, CTFA, AEP®, is a Lead Financial Advisor at Team Hewins, LLC, a wealth management firm with offices in South Florida and the San Francisco Bay Area.
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