More often than not, individuals are topic to state taxes within the states the place they dwell and/or earn their revenue. So when shifting to a lower-tax state or one other, their revenue tax burden likewise shifts to the brand new state together with them. Which is, for instance, why so many individuals choose to maneuver to lower-tax or no-tax states like Florida or Texas in retirement, the place they will get pleasure from decrease state revenue taxes and protect extra of their retirement financial savings to be used by themselves or their heirs.
However like many guidelines, there’s an exception: When an individual working in a single state defers a few of their revenue, then strikes to a unique state (the place they finally obtain the revenue), that revenue can in sure circumstances be taxed by the primary state (the place they labored once they earned the revenue) even when the individual now lives in a unique state. In different phrases, shifting to a lower-tax state will not all the time lead to paying decrease state taxes with specific sorts of revenue.
Particularly, USC Part 114 defines sure sorts of “retirement revenue” that may solely be taxed by the states during which an individual resides, which embody certified employer retirement plans and IRAs in addition to nonqualified deferred compensation plans which might be both paid out over a interval of a minimum of 10 years or structured as an extra profit plan. Nonetheless, different sorts of deferred revenue, together with fairness compensation plans like inventory choices and RSUs (which usually aren’t taxed till after a multiyear vesting interval) and nonqualified deferred compensation plans that do not meet the precise standards above, can nonetheless be taxed by the state during which that revenue was initially earned, even after the worker strikes to a unique state.
For advisors of workers who wish to reduce their state tax burden in retirement, then, understanding the various kinds of deferred revenue they might be receiving – and the way (and by which states) will probably be taxed – can assist to acknowledge planning alternatives that assist make sure the shopper’s targets of decrease taxes are literally met. For instance, some methods round worker inventory choices plans, akin to using Incentive Inventory Choices (ISOs) or making an 83(b) election on Nonqualified Inventory Choices (NSOs), trigger revenue from these choices to be acknowledged primarily as capital beneficial properties, which might be taxable solely within the state the place the worker lives once they truly promote the underlying inventory. And for workers with entry to nonqualified deferred compensation, confirming that the plan’s advantages pay out as a sequence of considerably equal periodic funds over a minimum of a 10-year interval ensures that they meet the definition of “retirement revenue” underneath Part 114. (And since nonqualified deferred compensation is historically provided solely to executives and different key workers, these workers might be able to affect how the plan is about as much as start with to make sure one of the best tax remedy!)
The important thing level is that when somebody strikes to a unique state for tax functions, generally the transfer itself is not sufficient by itself to perform that purpose, and extra cautious planning is important to see significant tax financial savings when deferred compensation is a part of the monetary image. Which finally implies that advisors with a deeper data of the state tax remedy of deferred revenue can assist guarantee that their shoppers’ expectations of decrease state taxes in retirement match up with the fact.
