Want to Move? Make Sure You Understand the State Tax System

As all of us Michiganders know, during our working years, we’re typically subject to a 4.25% state income tax. When you write that check for the tax payment, particularly in January or February, one can’t help but dream about moving to a sunshine state like Florida, which is warmer in January and has no state income tax. Just remember, things are never as simple as they might appear. Understanding a bit about state tax systems will help you determine what your real tax liability might look like on a big move.

A bit of history might be helpful. Since 1902, state tax systems have changed dramatically. Property and license taxes were once much more important, but over time states added income taxes, sales taxes, fuel taxes, tobacco taxes, alcohol taxes, and other revenue sources. Major events like the Great Depression, World War II, the end of Prohibition, and more recent economic shocks all pushed states to adjust how they raise money.

This history is worth remembering because many people focus mainly on state income taxes when thinking about where to live in retirement. Both Texas and Florida are known as two of the country’s no-income-tax states, but they are also the most consumption-tax-reliant states in America. On the other hand, states like California, New York, Massachusetts, and Connecticut rely heavily on individual and corporate income tax collections to fund their governments.

Across all states, the two largest sources of state tax revenue are personal income taxes and general sales taxes. Personal income taxes account for 32.6% of total state tax revenue, while general sales taxes account for 31.7%. Florida is an extreme example of the sales-tax approach, relying on the general sales tax for 63.5% of its state tax revenue. Michigan, by contrast, has a more diversified state tax collection system, combining individual income taxes, general sales taxes, corporate and business-related taxes, fuel taxes, tobacco taxes, and other selective excise taxes.

You may wonder how Florida can raise enough government revenue without an income tax. After all, while both Michigan and Florida rely on a sales tax, Michigan also has an income tax. There are a few reasons Florida can make that work. First, Florida effectively exports part of its tax burden to non-residents through general sales taxes paid by its many visitors — think Disney, cruises, conventions, and beach tourists. In addition, many Rust Belt states, including Michigan, have higher legacy costs tied to retiree obligations, aging infrastructure, and long-established public pension systems. Florida has lower public pension obligations and generally spends less on certain social programs.

So, if you are considering a possible move from an income-tax state like Michigan to a no-income-tax state like Florida, remember that taxes will still pop up. They will affect you, and they may also affect your winter visitors who are trying to get out of the cold. When those visitors come, they/you will spend on food and fun activities, and that spending will be taxed. And if you are retiring to Florida, all that free time may lead to more taxable spending of your own — including golf, which, by the way, may be worth every dollar of tax.

The larger point is that every state needs revenue; the difference is not whether residents pay taxes, but how and when those taxes are collected.

Fun Fact: One of the more unique taxes in the world may be Japan’s “bathing tax.” In certain hot spring areas, visitors can be charged a small local tax for using an onsen, or hot spring bath. For example, Niseko Town lists a bathing tax of 100 yen for one-day bathing and 150 yen for an overnight stay. So yes, in some places, even taking a relaxing bath can be a taxable event.

When It Comes to Michigan Real Estate, Don’t Take Your Cap Off

Property taxes are a major factor in real estate purchases. As some of you know personally, buying a new home in Metro Detroit can result in annual property taxes of $20,000 or more.

Michigan does have a beneficial property tax rule that helps long-time property owners, but can surprise subsequent buyers or heirs. The basic rule in Michigan is that a property’s taxable value generally cannot increase each year by more than the lesser of inflation or 5%. Thus, the taxable value is referred to as being “capped” at a limited growth rate.

Your property tax statement will show you both the taxable value and the state equalized value. Typically, if you’ve owned the property for a long time, the state equalized value (typically 50% of the true cash value) is substantially higher than the taxable value because of this capping rule. That’s because home prices have increased annually more than general inflation for many years.

The tax surprise comes when property gets “uncapped.” Uncapping can occur anytime you transfer ownership of real estate. The result can be substantially higher property taxes, because the taxable value is adjusted after the transfer, often closer to the property’s state equalized value.

Fortunately, there are some important exceptions that preclude the uncapping: Transfers between spouses and transfers to close family members are a few exceptions. Transfers to certain trusts, like your own revocable living trust, or transfers with a retained life estate (commonly known as Ladybird deeds) may also avoid uncapping in Michigan.

If you aren’t aware of the rules, you can inadvertently uncap a property tax value. A transfer to a family member precludes uncapping only if the property is residential and the relationship is one identified in the statute (spouses, children, siblings, and grandchildren are all covered). If the property is going to be used as a rental or for other business purposes, then the family exemption to uncapping does not apply. Transfers into an LLC can also uncap property, so they must be handled carefully.

You are required to let the assessor know about your transfer so that the property taxes for the new owner can be determined. This is done by filing a form called a Property Transfer Affidavit, which is required to be filed with the City or Township Assessor within 45 days. It’s on that form that the exception is listed to protect against uncapping. Failure to file the form can trigger a penalty.

Uncapping can cause serious financial consequences for cottages or farm property that have substantially appreciated over the decades. Before you fully commit to a real estate transaction, make sure that you ask lots of questions about the uncapping ramifications. It might be impolite to leave your cap on in a restaurant or church, but when it comes to real estate, keeping your cap on is always the goal.

Fun Fact: Michigan has two famous property tax laws that people often confuse. The Headlee Amendment (1978) limits government tax growth. Proposal A (1994) created the taxable value cap—and the “uncapping” rule that can cause property taxes to jump after a transfer of ownership.

When It Comes to Retirement Planning, the Word “Risk” Needs a Companion

Risk is an interesting word. When I looked up its origin, I found a reference to the Italian word “riscare,” which means “to run into danger.” That’s pretty broad.

When it comes to retirement planning and investing, the word risk usually connotes the amount of volatile investments one has or needs in their portfolio. Financial advisors are always trying to quantify risk for clients so they can help in investment selection. I’ve spent considerable time thinking about and researching the concept of risk and I’ve concluded that the word “risk” can’t stand alone. Several words need to be attached to it to guide clients in their investment journey. Here they are:

Risk tolerance: That’s the psychological willingness to take risk. This one sometimes gets too much weight. I write that not because it’s unimportant, but because it is hard to quantify. Sitting in my office talking to clients about their emotional willingness to take on risk is one thing. Talking to them in the middle of a market meltdown is quite another.

Risk capacity: This one relates to your financial ability to absorb losses. Will a big market drop affect your ability to maintain your lifestyle, now and/or later in life?

Risk required: This one sometimes gets overlooked. If you want to achieve your retirement goals, you must be able to accept the amount of risk required to maintain adequate portfolio growth over the long term. Because no two people have the exact same retirement goals, this factor varies greatly among my clients. What doesn’t vary is the effect of inflation on a slow-growth portfolio.

Risk behavior: You might remember my past reference to the following quote: “Everyone has a plan…until they get hit.” Setting aside what you think you will do in the future, reviewing how you actually behaved during past market declines is invaluable in predicting how you might behave during the next market tsunami.

There’s a lot to navigate when the topic of risk comes up in investing. There is no single set of questions that can be answered to settle the issue of risk. In my practice, I try to organize the factors in this way: Let’s look at your retirement goals to establish your required risk, then we can see if that matches your risk tolerance based upon your prior risk behavior. After we work through that exercise, we can set things up so you have the capacity to tolerate the risk you need to accept to meet your goals.

In some ways investing is easy and boring, kind of like a 1-0 soccer match. But behind the scenes, there’s a lot to consider. Here’s hoping you have the right advisor for the job.

 

Fun Fact: You’ve probably heard of an insurance underwriter who determines whether you are accepted for an insurance policy. The term underwriter originated in the late 1600s at Lloyd’s Coffee House in London. Merchants, shipowners, and investors gathered there to arrange marine insurance. A shipowner seeking insurance would write a description of the voyage, cargo, and amount of insurance desired. Wealthy individuals willing to insure part of the risk would literally write their names underneath the description and indicate the percentage of the risk they were willing to assume. Because they signed under the written proposal, they became known as “underwriters.”