The Perils Of Moving to a No-Tax State

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By JEANNE SAHADI

You might think that moving to a state with no income tax would greatly simplify your tax life. Not so fast.

If you're not careful, it could greatly complicate things and cost you tons in back taxes and penalties. For example, if you are still planning to spend significant time in your former state, you better limit it to less than 183 days.

Why? Spending any more time there could mean you'll be treated as a resident of that state and therefore have to pay tax.

And it's not just days spent in-state that tax authorities may scrutinize. They will look at a host of factors to see if you legally owe them taxes despite setting up a new home elsewhere.

"States will often take the most minute shred of evidence to make an assumption of residence and follow that path in pursuit of collecting state taxes," said CPA Jon Blakesberg of Boca Raton, Fla.

This issue, of course, doesn't only apply to people who move to states without income tax. And it isn't exclusive to wealthy people, but they are more likely to be shuttling between properties in different states and end up in the cross hairs of the taxman.

New York and California are known as particularly aggressive in pursuit of former residents who've moved to places like Florida and Nevada. (Texas, South Dakota, Washington, Wyoming and Alaska also don't impose income taxes, while New Hampshire and Tennessee only tax interest and dividend income.)

But other states may get more aggressive in pursuing former residents, now that technology lets them analyze data better and faster from places like the IRS, said Cara Griffith, editor-in-chief of state tax publications for Tax Analysts.

To avoid suspicion and prove that you've established legal permanent residence in the new state, you'll have to jump through some hoops.

As soon as you move, you should change your driver's license, car registrations, voter registration and mailing address for all bills and financial statements. You may also need to file a non-resident return to your old state if you earned any income there.

Even a minor oversight could create a headache, Blakesberg noted. One client, for instance, moved from Massachusetts to Florida, but the custodian of his retirement plan kept withholding Massachusetts tax on his annual distribution. The client ended up having some back-and-forth with Massachusetts tax authorities to remedy the situation.

It's also important to keep proof of how many days you actually spend in your old state. Requirements vary, but typically you must spend less than 183 days in a state to be considered a non-resident.

"If you're straddling the line closely, be prepared for more scrutiny," said Kathleen Thies, senior state tax analyst at CCH.

That's why tax experts advise clients who've moved to keep a meticulous travel log, complete with gas, toll and airline receipts, credit card records and the like.

And be prepared for some weird scheduling problems.

Still sit on the board of a company or other organization in your former home state? Better hope the quarterly meeting won't push you over the 183-day mark.

Will your flight back to your former city get in at 11:55 pm? Those five minutes in-state may count as a day against your total.

Now, no one's saying you can't maintain ties to your former state -- whether by having a bank account there or owning a property, or coming back to visit friends and family.

But it's a matter of degree. Where is your most active checking account? Where's your main office? Where do you return to most frequently after a trip? If you go to church on Sundays, do you spend more Sundays at your old church or your new one? Same goes for country clubs and gym memberships.

"The courts will look at the entirety of the record. It mostly comes down to 'Where is your life?' " said Verenda Smith, deputy director of the Federation of Tax Administrators.

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The Perils Of Moving to a No-Tax State
Not only does it have a Florida-like climate, but Tennessee also boasts the second lowest cost of living in the country. Combined with a low tax burden and great access to medical care, Tennessee is ideal for retirees living on fixed incomes, Kahn said. The only downside: the state has one of the country's highest crime rates.

One of the state's oldest towns, Sevierville, Tenn. (pictured above), provides close access to a national park where retirees can picnic, hike and fish, and it's an easy drive to Knoxville.
Another balmy locale, the state has an average temperature of 66.7 degrees -- behind only Hawaii and Florida for warmest average climate. Louisiana residents also enjoy low taxes, above-average access to medical care and a relatively cheap cost of living. Like Tennessee, though, it suffers from a crime rate that is among the nation's highest.

It may not be a retirement hot spot, but Bankrate says it should be. The state has the country's lowest crime rate, and an estimated state and local tax burden of just 7.6% -- lower than every state but Alaska. The downside: with an average temperature of 46 degrees over the past 30 years, it's pretty darn cold there.

For small town lovers, Aberdeen, S.D., holds a renowned film festival and has a historic downtown that plays host to farmers markets, haunted walking tours and holiday parades.

Photo: Conspiracy of Happiness, Flickr.com

The Bluegrass State is one of many Appalachian states to dominate Bankrate's top 10. While it may not have Florida's sunny beaches, it does boast an extremely low cost of living, warmer-than-average temperatures and a below-average crime rate.

In Louisville, retirees can stay active by walking or biking on the Louisville Loop, a pedestrian path set to eventually cover more than 100 miles. The smaller town of Danville, Ky., meanwhile, is ideal for horse lovers.

Beyond its warm weather, Mississippi also provides cheap living costs and a lower tax burden. But retirees may want to choose where they live carefully: the state has a high crime rate and subpar access to medical care. It has only 178 doctors per every 100,000 residents -- almost 100 less than the national average.

Photo: Natalie Maynor, Flickr.com

This coastal state came in above average for most factors that Bankrate analyzed, including climate, access to healthcare and cost of living. Its crime rate is one of the lowest in the country, with only 2,446 property and violent crimes per 100,000 people.

An affordable college town, Lynchburg, Va. offers the beauty of the foothills of the Blue Ridge Mountains, as well as historic Civil War sites.

Another Appalachian state, West Virginia is boosted onto the list by low crime, a cheaper cost of living and above-average access to medical care. Still, it has a colder climate than some of the other states.
Warm temperatures, low state and local taxes and a relatively low cost of living all pushed Alabama into the top 10. Yet it suffers from below-average access to medical care and a relatively high crime rate, with 4,026 crimes per 100,000 people -- almost double that of Virginia.

Home to a campus of the University of Alabama, Huntsville, Ala. offers botanical gardens and nature preserves and 19th century architecture. Near the Georgia border, Fort Payne, Ala. is a quintessential small town with activities that include an annual fiddling convention and a stop at the "world's largest yard sale."

Beyond its cornfields, Nebraska offers excellent access to hospital care, a below-average crime rate and living costs among the country's cheapest. But with a lower than average temperature, it's another state for retirees who don't mind the cold.
Like neighboring South Dakota, this state is not for retirees looking for warm weather. But it does have the second lowest crime rate in the nation, a mild estimated tax burden of 8.9% and 5 hospital beds available for every 1,000 residents.
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