Tax Overhaul: Final Straw for Many Californians

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As a financial adviser, one thing we regularly address with clients is the tax burden that hits higher-income individuals, and the savings they would rack up if they moved to another state. Among our clients in California, we have seen a mass exodus of higher-wage earners and retirees leaving the state … and the tax overhaul that passed Congress on Wednesday, Dec. 20, 2017, will cause even more to leave.

California has a highly progressive income tax structure, and personal income taxes make up the vast majority of the state’s budget. With a top tax rate of 13.3%, it has the highest state tax rate in the nation.

Over the years we’ve personally witnessed many of our clients leave California to more tax-friendly states, such as Nevada, Texas and Arizona. And we’re about to see many more pack their bags.

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One California family’s tax tale: A 35% increase

As the tax bill was being finalized in Congress, I received a call from a couple who wanted to see how this new tax bill would impact their family. This couple had been lifelong California residents, retiring a few years ago. They own two homes in California: one in the Palm Springs area and another in the Lake Tahoe region.

With a retirement income of roughly $200,000, made up of Social Security, a small pension, IRA distributions and dividends, they are hit with California taxes of about 10%. Unlike the federal government, where capital gains and dividends are taxed at more favorable rates, California hits all taxable income with the same high tax rates.

In addition to the high income taxes, they pay fairly substantial property taxes on their homes. It’s not that property tax rates are all that high in California (they are about 1.25% of the value), it’s that home prices there are astronomical.

One slight relief this couple has had (as have many California residents) has been their ability to deduct their state income and property taxes against their federal income taxes. This has effectively reduced the cost of their total taxes by 25%. Given that their combined income and property taxes is about $35,000 per year, their effective rate had been approximately $26,000 per year.

While the new tax bill awaiting President Trump’s signature may reduce their federal income taxes a bit, their effective California tax bills will increase by $9,000. That’s a 35% increase in taxes for the privilege of living in California.

Say hello to Texas

As I went through the numbers with this couple, they told me this was the last push they needed to leave the state. They already have one child living in Austin, Texas, and they told me that they would be selling one of their California homes and buying a primary residence in Texas. From our calculations, not only will this save them a ton in income taxes, but their overall cost of living will be much lower as well.

If California and other high-income tax states don’t do something to address this issues, we’ll see many more families flee to lower-taxed ones. Unfortunately, the federal government has made it much less appealing to pay state income taxes.

Defuse the Tax Bomb That Threatens Retirement

Things people in high-tax-states can do

But if you live in a high-income-tax state and you don’t plan to leave, here are few things you can do to minimize your tax burden for next year.

Because that the deductibility of state, local and property taxes will be capped at $10,000 starting in 2018:

Pay your April property taxes in December 2017, if your combined state income taxes and property taxes for 2018 will exceed $10,000.
Make an extra mortgage payment. If you itemize, then it could make sense to make your January 2018 mortgage payment in 2017.
Make 2018 charitable contributions in 2017, if your itemized deductions — less state income taxes — are under $24,000 if you’re married or $12,000 if you’re single.
Other deductions have been repealed as well, such as alimony, tax-preparation fees and casualty losses.
Keep in mind: state and local taxes can be added back under alternative minimum tax (AMT) for individuals; however, receiving any deductions is better than losing them altogether next year.

Take advantage of these deductions while you still can.

More changes are on the horizon that may directly impact you. The tax overhaul bill may very well cause major ripples in structural changes to Medicare and Social Security. And although I am not a tax adviser myself, I encourage my clients to meet with a tax professional to think through decisions before year’s end.

It’s always a good idea to review your investment portfolios every year. With major changes to the tax code on the horizon, now is a good time to make sure your financial strategies are sound and your portfolio is balanced to your best interest.

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Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Scott Hanson, CFP, answers your questions on a variety of topics and also co-hosts a weekly call-in radio program. Visit HansonMcClain.com to ask a question or to hear his show. Follow him on Twitter at @scotthansoncfp.