Moving to save capital gains taxes? Where do you go?

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In the age of Google, our tax clients have devised some of their most creative plans to save on taxes. Some of them are truly impressive, but I am always the most inspired by those dedicated to the idea of moving to a foreign country to forgo income taxes.

But does it really work? And where can your clients move to?

I have mostly seen this issue come up when clients are facing large, and often unanticipated income such as with capital gains taxes. A merger or acquisition has occurred, or a stock sale has closed and now a client is facing multiple six or seven figure tax bills they just don’t want to have to pay. While moving might sound like a ridiculous idea it can potentially work (sometimes).

Let’s cross the easier bridge first and stay stateside. There are some states who have tax laws more favorable when it comes to capital gains and depending on the circumstances this boost might be the right fit for your client.

North Dakota, Pennsylvania, and Indiana all offer capital gains tax rates around the 3% mark. Well below the federal rates of 15-20% and even below most state income tax rates. The national average state income tax rate is a hefty 8.9% on top of Federal taxes.

States with NO capital gains tax include Alaska, New Hampshire, Florida, South Dakota, Nevada, Tennessee, Wyoming and Texas. These states also boast no individual income taxes although both Tennessee and New Hampshire tax interest and dividend income.

These states might provide some savings, but clients need to plan wisely. To start, they must actually be residents in those states, and a move post earning of the income probably isn’t going to cut it. Typically states tax the income earned in that state, meaning if you move to save tax money AFTER you already have made the money, your move is probably a moot point.

What about moving overseas?

Puerto Rico has become an increasingly popular US tax haven. For one, it is considered US territory and doesn’t require that US citizens renounce their citizenship. After moving to Puerto Rico, residency must be established by spending more than 183 days in the territory and filing to establish residency.

Only then will future capital gains earnings be eligible for the lower rate of 4% in Puerto Rico versus the US capital gains rates. I have seen this strategy work in installment sale situations or when stock options have a vesting schedule and not all the stock is initially owned or vested on the moving date.

The short answer to a relocation strategy? It really only works with a very specific set of circumstances, oh and your client has to actually want to move. Often a relocation must stay in place for a specific amount of time. Puerto Rico moves have to be in place for a minimum of three years to valid for tax purposes.

If your client is asking you about relocation as a tax planning strategy, be sure you have carefully reviewed all the circumstances with them to ensure the strategy is actually going to work before they pack up their lifestyle. Often there are more realistic planning strategies that can help reduce their bill.

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