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California’s $16 billion budget hole has garnered headlines, as has Gov. Jerry Brown’s proposed fix, which includes tax hikes and budget cuts.
But from the boots-on-the-ground perspective of business relocation coach Joseph Vranich, in an interview with AdvisorOne, a further increase in taxes for the 48th ranked state in terms of tax burden (according to the Tax Foundation) will only exacerbate the problem.
“There’s always a tax comparison with another state,” says Vranich (left), whose Irvine, Calif.-based Spectrum Location Solutions serves clients from large corporations moving 1,000 employees to family-run companies moving 10 people. “Every client I’ve ever served has saved various taxes by moving out of the state."
Vranich has been tracking the numbers for years, and says he uses conservative public domain information that is beyond challenge but that really understates the problem. Officially, he says, 254 large companies left California last year, a rate five times higher than 2009, but he cites private economic modeling specialists that put the figure as high as 4,600 departures in 2010.
“My data is only the tip of the iceberg because there are so many companies that are [exiting] quietly,” he says, adding that the trend appears to be accelerating this year. Vranich is unaware of a cross-state database, but believes California has the highest number of business exits, and that “New York and Illinois are probably tied for second place.”
The top reasons prompting these exits are, in general, high taxes, excessive regulation and an environment of hostility to business.
“The No. 1 reason why a company leaves varies depending on whether they are in a profitable or unprofitable position,” Vranich says. “If you are profitable, the No. 1 reason is high taxes. If you are unprofitable, the No. 1 reason is the regulatory burden,” he says, noting that fees, fines and compliance costs are so significant that their elimination could be all that is needed to bring a company to profitability.
As for business hostility, Vranich cites as an example a wholesaler whom the City of Los Angeles invalidly reclassified as a retailer, assessing two years of back taxes that would cost him $200,000. When he showed up to a meeting to fight the unilateral decision, a Department of Finance employee greeted him with the words, “The enemy has arrived,” eliciting the chuckles of his staff.
But the businessman was not amused. He had to fire two employees to pay the incorrect assessment while hiring a lawyer to restore the correct tax classification.
The top destinations for exiting California businesses are Texas and Arizona, and the reasons are these states exhibit the opposite of California’s negatives. “Taxes are lower, the regulatory environment is more gentle and government agencies more cooperative,” Vranich says.
Other factors besides taxes, regulation and government hostility can play a determining role in business relocation decisions, he says. Lifestyle concerns, such as a preference for four seasons, have impelled some clients to choose Colorado, for example.
And for professional service firms such as financial advisors, lawyers and accountants, the cost of hiring employees tends to be the critical factor. ”A software maker can save between 30 and 40% of the cost of an employee if he hires him outside the borders of the state of California,” Vranich says, citing special rules that make software development costlier in California. “[Non-software] companies can save 20 to 30% in hiring outside of California,” he says, adding that firms may want to keep their headquarters here but staff their back office outside of the state.
The business relocation consultant warns businesses exiting California to be careful about establishing their residency in their new state, citing very aggressive monitoring by California tax authorities.
“If it’s a family-owned company, you can’t just move the company out of California and reduce your tax liability,” Vranich says. “With LLCs and S-corps, all the profits flow to the owner. You’ll get the compliance savings and lower real estate taxes,” he says. But you will also get a tax bill from California if your kids are still attending school in the state or if your phone bills or flight patterns demonstrate a pattern that the state’s Franchise Tax Board regards as proof you live in California more than 50% of the time.