Although many wealthy taxpayers are worried about Washington's plans for tax increases, financial advisers and other tax experts are sounding the alarm bell about state tax hikes.
Although many wealthy taxpayers are worried about Washington's plans for tax increases, financial advisers and other tax experts are sounding the alarm bell about state tax hikes.
“States are scrambling for money,” said Mark Robyn, a staff economist at the Tax Foundation, a non-partisan research group, who noted that a few have already raised taxes on the wealthy, and others may be pressed to do so to bridge yawning budget gaps.
Combined with a top federal tax rate of 39.6% expected when current rates expire in 2011, top earners in many states could be paying taxes at a marginal rate of 50% or more, he said.
“It could be a double whammy for some people,” Mr. Robyn said.
Last year, the states that raised taxes on the wealthy — either temporarily or permanently — were California, Connecticut, Delaware, Hawaii, New Jersey, New York, North Carolina, Oregon and Wisconsin.
“A number of our clients were caught off guard,” said Richard Schroeder, executive vice president of Schroeder Braxton & Vogt Inc., an Amherst, N.Y., financial advisory firm that manages $220 million in assets.
Some clients asked that they be given “a couple thousand dollars” from their accounts to pay for the unexpected tax burden, he said.
For relief, some advisers are recommending that their clients invest in tax-exempt bonds issued by the state in which they live or by municipalities within that state. Interest paid by such bonds is tax-free on both the state and federal levels.
“We use New York tax-free muni bond funds despite concerns about the state's finances,” Mr. Schroeder said. “It's a liability, but we think it's worth it to avoid taxable New York interest.”
Other advisers — particularly those in California — aren't so sure.
California's perilous fiscal condition — worse than that of other troubled states, including New York — will continue to pressure California bond prices, said Jack H. Scaff III, vice president of Brouwer & Janachowski LLC. The Tiburon, Calif.-based firm has $800 million under management.
“Currently, we're not using a whole heck of a lot of California muni bonds, because of the risk,” he said.
Advisers who are steering clear of muni bonds are working on other ways to ease the impact of higher taxes.
“You've got to start off with overall good tax management and build that process from the top down,” said Chris Cordaro, chief investment officer of RegentAtlantic Capital LLC, a Morristown, N.J., advisory firm with $1.8 billion under management.
That process starts with asset location and dividing investments among taxable and tax-exempt accounts in a way that defers taxes and ultimately provides the best after-tax returns, he said.
Beyond such strategies, there is very little that investors can do to lesson the effect of state taxes, said Harold Evensky, president of Evensky & Katz Wealth Management in Coral Gables, Fla., which manages more than $600 million in assets.
“I don't know of any other substantive things you can do other than re-establishing your residence in another state,” he said.
Moving from a high-tax to a low-tax state isn't something that comes up frequently, Mr. Evensky said, though he has had clients who have changed their state of residence to Florida from New York for tax purposes.
E-mail David Hoffman at dhoffman@investmentnews.com.
