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.
“A business owner focused on future income tax savings may not be too concerned with taking the necessary measures to save tax in the state where they already live,” McGrory added. “For example, while an asset sale may be an easier and sometimes more expedient option to sell, a sale of the business owner’s stock could possibly result in a better outcome.”
“There are pre-sale planning techniques that can move the sale out of the higher tax state and into a more desirable state. The proposed transaction must fit a specific fact pattern and must be recognized by the departing states,” Kazakewich said. “There are also gifting strategies and discounted sales, which in conjunction with trust strategies, can yield significant tax savings.”
Tax insurance can help manage this risk, Harger said, and can be acquired at the time of the relocation or down the road to protect a taxpayer from the economic loss arising from a future tax authority challenge.
“It’s designed to take the taxpayer back to the same position they would have been in if there had never been a tax authority challenge by covering additional assessed amounts, costs of a contest and so on,” she said.
An ill-conceived move can cause more than tax trouble: Selling a business also opens the door to more scrutiny of a company’s underlying tax profile by a prospective buyer.
“A seller must consider not only the tax impact of the sale itself, but potential tax risk associated with their historical positions, as well,” Harger said.