JD Montgomery, a California investment adviser whose clients have an average net worth of $75 million, was popular in the days after the November election, receiving about a dozen calls from clients about taxes and whether to leave the Golden State.
The reason for their desire to exit? Multiple higher federal taxes combined with rising levies in states including California. The bigger tax bite is pushing some top earners to buy properties across state lines, move businesses, change the jurisdiction of trusts and reduce gifts to charity.
“It's a double whammy,” Montgomery, managing director at Newport, California-based Canterbury Consulting, said of increased federal and state taxes facing some top earners. “We are at a tipping point.”
California and New Jersey along with the U.S. government and France have turned to tax increases on high-income residents to plug budget holes. While higher rates haven't caused a mass exodus historically, the current rates are leading golfer Phil Mickelson to say he's thinking about making drastic changes and have caused French actor Gerard Depardieu to cross the border. Other top earners have already made moves or are calculating with their advisers whether they should.
The groundswell of frustration that is turning into action so far is most apparent in California, where voters in November approved a tax increase retroactive to Jan. 1, 2012. The tax rate on income exceeding $1 million jumped to 13.3 percent, the highest of any state, from 10.3 percent.
That means wage earners in California will pay a top marginal rate of more than 50 percent when adding in federal tax increases that lawmakers passed Jan. 1, and those taking effect as a result of the 2010 health-care law.
Congress increased the top income-tax bracket to 39.6 percent from 35 percent and applied it to taxable income exceeding $450,000 for married couples or more than $400,000 for individuals. High earners also face limits on the value of their deductions and exemptions, pushing up their rates, and an added 0.9 percent health-care surtax on wages.
“The cumulative effect of multiple increases, summing up to be significant, should concern policy makers,” said Joseph Seneca, an economics professor at Rutgers University's Edward J. Bloustein School of Planning and Public Policy in New Brunswick, New Jersey.
Golf champion Mickelson, who lives in California, said last month that he would make some “drastic changes” because of higher taxes.
“I happen to be in that zone that has been targeted federally and by the state,” Mickelson said. “It doesn't work for me right now, so I'm going to have to make some changes.”
While it's not a frenzy, top earners are making moves and being more proactive, said Teresa Ridge, senior director of planning in California at Wells Fargo & Co.'s unit that caters to those with at least $1 million invested with the bank.
“These are people with the means and resources” to act, she said.
Ridge said one Wells Fargo Private Bank client, who lives in California, bought a home in Nevada, which has no state income tax, just after the election. The San Francisco-based firm also is helping a chief executive officer in his mid-40s, who resides in California, buy a second home in Nevada, where he plans to be a resident by the time he sells his business within five years, she said.
The savings could be significant, Ridge said. A millionaire with $100 million in gains from the sale of a business might save as much as $13.3 million in state income taxes if the firm and family resided in Nevada compared with California based on current rates, she said.
“Nevada seems to pop up quite a bit, especially because housing prices are very attractive and inventory bountiful,” Ridge said.
Texas is drawing top earners as well, said Montgomery of Canterbury Consulting, which advises families with an average of $75 million in net worth. One client who lived in California moved to the no-income-tax state at the end of 2012 for tax purposes, he said.
Other California families with businesses held in trusts have moved them to South Dakota to take advantage of that state's favorable tax and trust laws including rules allowing the entities to last for multiple generations, Ridge said. Restructuring such accounts is complex and people must make sure they don't violate state or federal tax rules when doing so, she said.
Research is mixed as to how much tax policy influences behavior, Seneca said. Other factors influence moving decisions such as weather, employment opportunities, children's education and being closer to family and friends, he said.
A 2011 paper by Cristobal Young of Stanford University and Charles Varner at Princeton University found that New Jersey's higher taxes for top earners had little effect on migration.
A report the next year co-authored by Charles Steindel, the chief economist of the state's Treasury Department, had different results. It estimated the state lost 18,000 taxpayers and $2.4 billion in annual income from 2003 through 2010 after tax increases for top earners.
“If you raise taxes you're likely to lose some people,” Steindel said. “It's something that adds up over time.”
France to Russia
While most people won't go as far as the actor Depardieu -- who got citizenship in Russia last month to avoid higher taxes in France -- more people may make changes because of the multiple increases targeting high earners, said Montgomery of Canterbury Consulting.
John Franson, a 42-year-old financial analyst in Boston, said he and his wife wouldn't mind paying a little bit more if they saw lawmakers put a constructive plan in place to reduce the budget deficit.
“We don't see that,” he said. “We see class warfare. We see the finger pointing that the top 1 percent caused all the problems.”
The couple will pay a top marginal rate of more than 51 percent this year, with federal and state taxes combined, Franson said. He said he's going to cut back on donations because he'll have less disposable income and he expects more increases.
Massachusetts Governor Deval Patrick called last month for an increase in the state's flat income-tax rate to 6.25 percent from 5.25 percent. President Barack Obama and congressional Democrats want to raise more revenue by curbing tax breaks.
“Instead of giving a couple grand to charity, I'm keeping it,” Franson said. “A good portion of our income and any increase in our income will be taxed at the 39.6 percent federal rate, which doesn't make us want to work much more.”
Those who want to change residency to another state must be able to prove that they are physically there a majority of the time, said Steve Henley, national tax practice leader at the accounting provider CBIZ MHM LLC. They would want to buy a home, register to vote and get a driver's license, he said.
Top earners can use less dramatic planning strategies such as maximizing their contributions to retirement plans to reduce their tax bite, Henley said.
Review of investment portfolios is critical, said Alfred Peguero, a tax partner in the private company services practice at PricewaterhouseCoopers LLP. People may want to consider tax- exempt municipal bonds of the state in which they reside, said Peguero, who is based in San Francisco.
Keeping up-to-date records of income, expenses, home improvements and charitable donations will be more important this year for high earners, he said.
That's partly because the higher federal income taxes apply to taxable income exceeding $450,000 or $400,000, which taxpayers can reduce through itemized deductions, said Michael Eisenberg, a certified public accountant and financial planner at Eisenberg Financial Advisors in Los Angeles.
“Some of these increases are not going to be outrageous” at the federal and state level for couples making $500,000 or $600,000, he said. “Run the numbers before you panic.”