Lower-tax locations may appeal to business owners more than ever these days, but those clients may not consider all factors before hauling up stakes or selling a business.
The temptation is nevertheless obvious. “Many states in the Northeast have high individual income tax rates and, when compared to a zero-income tax rate state like Florida, moving can be quite a compelling proposition,” said James G. McGrory, a CPA and shareholder at Drucker & Scaccetti in Philadelphia.
“If clients are considering moving businesses to more tax-favorable states, it’s not just a tax decision but one based on quality of life,” added Mike Kazakewich, a partner, advisor and director of planning at Coastal Bridge Advisors in Westport, Conn. “Considerations include the talent and labor pool, cost of living and overall business environment of the new state.”
“You need a holistic approach to weigh tax savings against other costs, including intangibles,” said Matthew Heckler, director of corporate executive services at Telemus Capital in Southfield, Mich. “New York City is prohibitively expensive, for example, yet companies want to set up shop there—Covid aside—for other reasons, such as access, talent and prestige.”
Business owners need to remember that tax jurisdictions use a lot of tools to generate revenue, including real estate taxes, franchise taxes, local earned income taxes, sales and use taxes, inheritance taxes and state and local business fees. One key question: If there is a significant tax benefit, is it supportable—or is there risk of lengthy and costly litigation in the future?
“It can be tempting to relocate before tax is triggered on the sale [of a business]. Tax authorities are very aware that business owners may try to take advantage of this,” said Jessica Harger, managing director of Aon Transaction Solutions. Those authorities “heavily scrutinize the facts and circumstances of a change in residency, particularly if there’s a significant tax impact and lost tax revenue.
“In an audit potentially years after the sale, the tax authorities may look into the amount of time the business owner was residing in the new location before the sale,” Harger said. “If it’s not clear that the business owner truly changed their residency to the lower-tax state and that all facts and circumstances support the change, the seller could end up with an unexpected and material tax bill.”
Another key: Has the business owner structured the sale terms to maximize net after-tax cash flow? “With an asset sale, many tax-saving strategies become moot,” Heckler said.