October 2020 – Mackey Tax Professionals and Financial Services, Inc.

Dear Client:

If you’re considering moving to a different state, taxes in the new state may be the deciding factor – especially if you expect them to be lower.

Consider All Applicable State and Local Taxes

If your objective is to move to a lower-tax state, it may seem like a no-brainer to move to one that has no personal income tax. But that’s not a no-brainer!

You must consider all the taxes that can potentially apply to local residents – including property taxes and death taxes.

One Case Study

Texas is “famous” for having no personal state income tax, while Colorado has a flat 4.63% personal state income tax rate. So, you might reasonably think it would be much cheaper taxwise to live in Texas than Colorado if you have a healthy income. Not necessarily! Here’s why.

The property tax rate on a home in some Colorado Springs locales is about 0.49% of the property’s actual value, as determined by the county assessor. Say you move to one of these areas and buy a $500,000 home. Your annual property tax bill would be about $2,450.

Say your taxable income is $200,000. Your Colorado state income tax bill would be $9,260. Your combined property tax bill and state income tax bill would be about $11,710 ($2,450 + $9,260).

According to the Dallas Central Appraisal District’s online property tax estimator, the annual property tax bill on a $500,000 home in some Dallas locales would be about $21,200, or about $17,800 if you’re over 65 or a surviving spouse. You would have no state income tax bill.

In most areas within both Colorado Springs and Dallas, the combined state and local sales tax rate is 8.25%, so no difference there.

So the relevant comparison for property and income taxes is $11,710 in Colorado Springs and about $21,200 (or $17,800 if you’re over 65 or a surviving spouse) in Dallas.

But if your income is really high, it could be the other way around – assuming you don’t buy a really expensive home in Dallas.

Finally, it’s important to know that the restaurants are better in Dallas. True!

Defang the State Tax Domicile Issue

If you decide to make a permanent move to a lower-tax state, it’s important to establish legal domicile there in order to decouple yourself from taxes in the state you came from.

The exact definition of “legal domicile” varies from state to state.

In general, your domicile is your fixed and permanent home location and the place where you plan to return, even after periods of residing elsewhere.

Because each state has its own rules regarding your domicile, you could wind up in the worst-case scenario – with two states claiming that you owe state taxes because you established domicile in the new state but did not successfully terminate domicile in the old state.

Finally, if you die without clearly establishing domicile in just one state, both the old and the new states may claim that state death taxes are owed. Not good!

If you are thinking of moving to another state, please don’t hesitate to ask me for help. My direct line is 828-424-1645.

Sincerely,

James G. Mackey

Dear Client:

Okay, so you took the big Section 179 expensing deduction on your vehicle.

How do you keep it?

You might wonder: What do we mean by “keep it”?

In tax law, there’s no free lunch. The Section 179 deduction comes with “recapture strings” attached.

When you claim your Section 179 deduction, you make a deal with the government to keep your business use above 50 percent during the “designated” depreciation periods (five years for vehicles).

One Sad Story

In 2018, Jerry Jackson claimed a $53,000 Section 179 deduction on a qualifying pickup truck. In 2020, Jerry’s wife drives the truck and Jerry’s business use drops to zero.

Jerry violated his 50 percent business-use agreement with the government. Now he has phantom income to report (called “recapture”), and he’s going to pay the price for breaking his tax promise on the Section 179 deal.

The pickup truck is listed property. This means that Jerry must recompute his allowable deductions using the ADS straight-line depreciation tables, which will result in the following:

$5,300 deduction (10 percent of $53,000) in 2018
$10,600 deduction (20 percent of $53,000) in 2019

In 2018, Jerry deducted his 90 percent business cost ($53,000) using Section 179. But now, with recapture, his ADS straight-line depreciation for 2018 and 2019 totals only $15,900 ($5,300 + $10,600).

So in 2020, the year of violation, tax law recaptures $37,100 ($53,000 – $15,900). Jerry must report the 2020 recapture income on the same form or line on which he (or his corporation) claimed the original $53,000 deduction in 2018.

For example, say Jerry operates as a proprietor who claimed his 2018 Section 179 deduction on Schedule C. In 2020, he reports the recapture income as other income on Schedule C.

Holy smokes! On Schedule C, that means the Section 179 recapture is going to create self-employment taxes. Correct! The original Section 179 deduction reduced self-employment taxes.

On his recapture income, Jerry gets the double whammy: increased income and self-employment taxes.

Traps to Consider

Retirement. Are you going to retire? Will retirement bring your business use to zero?

Children. Do your children drive your business vehicle(s)? Will their driving bring your business use to 50 percent or less?

Spouse. Does your spouse drive your business vehicle for personal purposes? Will your spouse’s mileage drop your business use to 50 percent or less?

Personal use. Are you converting Section 179 assets, such as a vehicle, to personal use? Does the conversion to personal use occur during the recapture period?

You need to consider recapture when doing your tax planning. If you would like my help with this, please don’t hesitate to call me on my direct line at 828-351-7205.