In Minnesota we are accustomed to paying lots of state income tax. We have the 20th highest state tax. Typical state and local taxes in Minnesota amount to 11.57 percent of adjusted gross income — about 7.56 percent more than the national average according to wallethub.com.
While it stinks to pay so much in state taxes, in years past, we have at least been able to deduct those taxes paid in one year from federal income taxes due next year. That was true until the new Tax Cuts and Jobs Act passed. The law limited SALT deductions to $10,000 per year. This is a particular problem for those in high-tax states like Minnesota. One has to wonder: how do we manage the new SALT limits?
- Bunching deductions.
To offset a reduced tax deduction for SALT, you can consider a strategy called “bunching” which shifts charitable contributions and other deductions out of one year and into the next year. The idea is that in Year One you take the new larger standard deduction and put off charitable contributions. In Year Two you make twice the amount of charitable deductions, pre-pay some mortgage interest, pay elective medical expenses and pre-pay real estate tax. This should create a deduction larger than the standard deduction in Year Two.
By planning ahead in this way, some can increase the total deductions they claim while spending the same money over time. It can be a little tricky so consult with your tax advisor to evaluate this strategy for you.
- Consider a donor-advised fund.
A donor-advised fund helps you make multiple years’ worth of charitable gifts in one tax year, claim it all on that year’s taxes and then distribute the gifts at a later time. If you plan to make substantial charitable gifts over time, this could be a great idea.
- Make qualified charitable distributions from your IRAs.
Qualified charitable distributions from your IRAs are a great option if you are age 70½ and over. If you are better than age 70½ and own an IRA, or are the beneficiary owner of an IRA, you can make a qualified charitable distribution up to $100,000 from the IRA to your charity. The distribution does not reduce your taxes, but the transfer is free from the usual income taxes you normally pay on such a withdrawal. And it satisfies the requirement for a minimum annual IRA distribution. And each spouse can contribute up to $100,000 each year.
- Relocate to a low-tax state.
Some Minnesota retirees change their state of residence at retirement. Florida, Arizona, South Carolina, and Delaware are all popular options. If you like to vacation away from Minnesota for part of the year, it can be a natural adjustment. But there are a couple things to carefully consider:
- Many states with lower state income tax have higher taxes and expenses in other areas. For instance, in Florida, homeowner’s insurance costs considerably more. In some states, local sales taxes can be meaningful.
- State-appointed auditors often go to great lengths to disprove claims of a new home. Bloomberg has reported that New York’s Department of Taxation and Finance is very serious about keeping their wealthy clients paying taxes in New York. Auditors will test New York residents looking for an out by using a domicile test based on five factors:
- Other residences owned
- Where the taxpayer spends most of their time
- Where their treasured items are kept
- Where business is conducted
- The location of the taxpayer’s family
- New York residents will also need to meet the “183-day rule” if they plan on moving but keeping a residence in New York state. They must prove that they haven’t spent more than 183 days per year in New York, and any day where there is no proof can be counted as a day in-state. Even entering the state’s boundaries for one hour can make the day count as an in-state day.
- Auditors can go after taxpayers by issuing subpoenas for credit card statements, using phone records to track the taxpayer’s location, and even confirming where they go for doctor’s appointments.
If you are thinking about changing the state of your official residence, just be sure that you really like the idea of moving your “life” to the new state.
While it’s a drag to not be able to deduct as much for state and local taxes, some thoughtful tax planning can make a real difference. Like all aspects of financial planning, each families’ situation is different. It pays to consult with your own CERTIFIED FINANCIAL PLANNERTM professional.
If this article has you thinking about smart ways to reduce your taxes and move toward your financial goals, contact my office at firstname.lastname@example.org. I am always happy to meet with people who are working on their financial goals. Dunncreek Advisors does not provide legal or tax advice, nor is this article intended to do so.
This blog is designed to provide accurate and authoritative information on the subjects covered. It is not, however, intended to provide specific legal, tax, or other professional advice. For specific professional assistance, the services of an appropriate professional should be sought.