Is moving out of state to avoid the estate tax a good idea?
Does the Washington state estate tax got you thinking of moving away? Maybe other things have you considering relocating and the estate tax is just the straw that broke the camel’s back? Perhaps you are lucky enough to own a second home in Arizona or another state and think you can just spend a little more than half your time at your second residence to avoid the estate tax. The analysis is more nuanced for both the tax issue and for the idea of what it means to be a resident.
But first, a refresher. What is the Washington estate tax burden?
The state imposes an estate tax on estates valued at over $2,193,000. The amount of tax starts at 10% of the first million dollars above the exclusion amount (above $2,193,000) and can go as high as 20%, depending on the total value of the estate.
There are deductions that can help to reduce or eliminate the estate tax (things like farm deductions and family-owned business interests). But, the state estate tax is the highest marginal estate tax in the country. Keep in mind that the value of the estate includes everything you own and even includes life insurance, which is generally not subject to income tax but is subject to the estate tax.
Can I avoid the tax by moving?
There are nuances to consider. Several states, such as Arizona, do not impose any estate tax burden on residents. Accordingly, some people, who may own a second home in Arizona, choose to formally change their residence from Washington to Arizona to avoid the estate tax. And it may work, but the plan to move should look to the specific asset ownership (property located in Washington may still be subject to the estate tax even though the owner doesn’t live in Washington) and the circumstances to substantiate the move of “residence.”
On the latter issue, one might appreciate that the state of Washington is in the business of collecting properly due estate tax.
Accordingly, the state might try to assert jurisdiction over your estate (i.e., claim you are a “resident”) if you move under questionable circumstances. For example, let’s say you spend 183 days in Arizona – does that alone make you a resident of Arizona?
The state of Washington will ask you (or more precisely your executor) a series of questions to help determine the state of residency of a decedent when residency might be in dispute.
The form is available on the Washington Department of Revenue website for further analysis.
But, in brief, it asks things like: (1) where are vehicles licensed; (2) where did the decedent (the person who died) vote; (3) where did the decedent attend church or other social or community organizations; (4) what property did the decedent own in Washington; (5) an itemized list of every single visit to Washington in the five years before death and the reason for each, etc.
The form can then potentially be used by the Department of Revenue to assert its jurisdiction if the facts and circumstances warrant it. I, for one, would be extremely uncomfortable if my plan was simply to spend a little more than half time in another state while otherwise maintaining other existing connections with Washington to avoid the Washington estate tax.
Consequences of moving
Moving out of state might thwart the Washington estate tax but might subject a person to additional tax or might cause a person to lose out on income tax benefits. For example, moving to another state might cause a person to start paying a state income tax (Washington has none, except the new capital gains tax). The additional income tax exposure should be weighed against estate tax savings.
One important benefit available to citizens of the so-called community property states (of which there are currently nine) is the benefit of getting a step-up in tax basis on all community property after the death of a spouse.
What this means is there is potential for big income tax savings after the death of a spouse because the tax basis of all community property gets stepped up to current fair market values which can result in the reduction or elimination of income tax on capital asset appreciation.
As a reminder, tax is assessed on the sale of a capital asset based on the difference between the tax basis and the amount paid. So, if tax basis is stepped up to current fair market value, that difference can become smaller or non-existent. In non-community property states, only the assets owned by the decedent spouse are entitled to receive a step-up in tax basis.
What does one do?
From a tax perspective, you may want a state that has no estate tax, no income tax and community property laws. Of course, there are other taxes to consider (property tax, sales tax, etc.), but one piece of advice is to not let the tax tail wag the dog. That is, perhaps tax considerations should take a back seat to other important items – things like community, family and friends. But, for a thorough analysis of your personal tax situation, you should consult a professional tax advisor.
Beau Ruff, a licensed attorney, is the director of planning at Cornerstone Wealth Strategies, a full-service independent investment management and financial planning firm in Kennewick.