Why Tim Ferriss moved to Austin… or why you should earn in California and retire in Florida

TL;DR: If you live in a high income tax (HIT) state (e.g. California, Oregon, Hawaii, New York), you can reduce your tax bill through the use of tax deferred investment plans and proper tax planning for large capital gains. It will require you to eventually move to a no-income-tax (NIT) state like Texas or Florida, but if you shift the realization of that income to a later time and place, you could save up to 13.3% in tax (in the case of California). This will help you keep more of the wealth you accumulate, and will enable your passive income to go a lot further!

Disclaimer: I am not a financial advisor or tax attorney. I strongly condemn any form of tax evasion. The below information is meant to highlight options for individuals within the current constructs of State and Federal tax laws at the time of writing. It’s possible these laws will change.

In 2017, Tim Ferriss, a popular writer, podcaster, and angel investor, moved from the Bay Area to Austin, Texas. His stated reasons for the move were a love for Austin and a growing disdain for the ‘closed-minded’ intellectual atmosphere of the Bay. While those reasons seem … well … reasonable? The cynic in me suspects an ulterior motive. Tim has made it publicly known that a large share (>50%) of his net worth is now tied up in private company stock – the largest of which is Uber. With an Uber IPO (no pun intended) on the horizon for 2019, Tim will likely sell a good chunk of his shares to diversify his wealth. This is likely to generate capital gains in the tens of millions for him, which is no doubt a contributing factor to his decision to move away from the Golden State. In doing so, he can keep an extra $1.33M after tax, for every $10M in capital gains he stands to realize.

California has the highest income tax of all US states. It tops out at 13.3%. The next closest states cluster around 9-10%:

  • California 13.3%
  • Oregon 9.9%
  • Minnesota 9.85%
  • Iowa 8.98%
  • New Jersey 8.97%
  • Vermont 8.95%
  • District of Columbia 8.95%
  • New York 8.82%
  • Hawaii 8.25%
  • Wisconsin 7.65%

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What’s worse, is that California’s 13.3% applies to all types of income – earned, passive, capital gains – meaning capital gains get no special treatment. While the Federal government tops out capital gains at 20% (as opposed to 37%), California provides no such relief.

The reasons for this are complicated, but the implications are pretty clear: You can save a lot of money by limiting / deferring the amount of tax you pay to the state. This can be done in two main ways:

  1. Maxing out tax-advantaged / tax-deferred investment plans (e.g. 401K, IRA / Roth, 529 college savings plans)
  2. Planning the timing of your capital gains

Let’s dig in a little deeper.

Max out tax advantaged plans

The strategy here is simple: put as much money into tax-deferred / tax-advantaged accounts as you can while you live in the high cost state. Max out 401K. Use every penny of your backdoor IRA-to-Roth conversion. Put as much as you can into your children’s 529 college savings plan. Every dollar of tax you defer or shield while in the high cost state could save you up to 13.3% in taxes if / when you move out of state later in life. If you’re in the top bracket, this could take your marginal tax rate down from 50.3% to 37% (25% lower).

There’s limited risk to this strategy, because even if you end up incurring a Federal tax penalty for those tax advantaged accounts, you could still come out ahead. For example, you could put money in a 529 college savings account, never end up using it for education expenses, and then take the money out of that account once you’ve moved from a high-income-tax (HIT) state to a no-income-tax (NIT) state. Yes, you’ll pay 10% extra to the Federal government, but you might even come out ahead if you deferred the 13.3% in taxes that would have otherwise been paid to California.

Plan your capital gains

The other strategy to consider is around the realization of capital gains. Today, states don’t tax you on unrealized capital gains when you choose to become a non-resident. Therefore, if you expect a large capital gain in the future (a la Tim Ferriss described above, or because you plan to sell some of your Amazon stock), then moving to a NIT state will save you that 13.3% tax as well. On capital gains, this is even more pronounced, because it will take your top marginal tax rate down from 37.1% to 23.8% (35% lower).

Make sure you become a proper non-resident

Of course, to make this work, you need to make the move from the HIT state to the NIT  state properly. First, figure out which state you want to move to. There are seven NIT states:

  • Alaska
  • Florida
  • Nevada
  • South Dakota
  • Texas
  • Washington
  • Wyoming

Next, figure out what criteria your HIT state uses to determine residency, and make sure you check all the boxes. For California:

A California resident is anyone in the state for other than a temporary or transitory purpose. It also includes anyone domiciled in California who is outside the state for a temporary or transitory purpose. The burden is on you to show that you are not a Californian. Source

Some of the specifics to consider with California include:

  • Time spent in state (If you’re in California for more than 9 months, it’s presumed you’re Californian)
  • Place of employment
  • Where you own and operate a business (along with allocation of time among them)
  • Primary home ownership
  • Residency of spouse and children
  • Children’s school district / attendance
  • Social, religious and professional affiliations
  • Voter registration, vehicle registration, Driver’s licenses

These are not difficult hurdles to cross, but it does require you actually moving to a NIT state. It would be difficult (not to mention immoral and illegal) to try and game the system. I expect the California Franchise Tax Board will track you down and make your life unpleasant if you do.

So to close, you can see the potential impact of making a move from a HIT state to a NIT state, particularly if you expect a large windfall in the form of capital gains. If you live in a HIT state, you should be maxing out your tax-advantaged accounts, and planning for a future where you might move to a NIT state to take advantage of those tax savings. Or even better, you could consider moving abroad for a year or two. Try living in Europe or Asia, and timing some of your income realization for that time. Yes, you’ll still have to pay Federal taxes on that income, but you’ll avoid the painful taxes imposed by your current HIT state. With these sort of things, consult a financial advisor or tax attorney to make sure your paperwork is in order.

As always, enjoy the journey!

Ramen-san

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