New Jersey may be the first, but probably not the last, state to raise taxes on the wealthy as a result of a steep decline in revenues due to the COVID-19 pandemic, creating challenges for advisors and their wealthier clients.
Last Thursday, New Jersey’s multimillionaire Democratic governor, Phil Murphy, said he had reached agreement with state legislative leaders to raise the state’s gross income tax rate on income between $1 million and $5 million from 8.97% to 10.75%, effective for the 2021 fiscal year.
The tax hike is part of the fiscal 2021 budget package, which is expected to be approved before the end of the month and take effect Oct. 1.
The tax would apply to income earned in 2020, according to a spokeswoman in the state’s treasury department. It is expected to raise $390 million in annual tax revenue. Residents earning over $5 million were already subject to the additional tax, dating back to 2018.
As part of the latest tax deal, the governor and legislative leaders also announced a $500 rebate for households with at least one child with incomes under $75,000 (for single taxpayers) and under $150,000 for a couple filing jointly.
Murphy had been pushing for a millionaire’s tax since he took office in 2018. It took the financial shortfall created by the pandemic and the perpetual need for the state, like all others, to balance its budget to convince state Senate leader Stephen Sweeney, who had previously opposed the tax, to go along with it.
“None of this is a surprise,” said Megan Gorman, the founder and managing partner of Chequers Financial Management, which is based in San Francisco but has clients in New Jersey and other states. “This is a trend that is going to be happening across the country.”
Two bills introduced in the California Assembly earlier this summer would have raised taxes on millionaires — one targeted just billionaires. They failed to gain traction but could be reintroduced during the state’s next legislative session.
Will Millionaires Flee the State?
Until many more states adopt similar income tax hikes on millionaires, some wealthy residents in New Jersey may choose to leave the state. They already pay relatively high property tax rates, which are no longer fully deductible due to the 2017 tax law limiting that deduction to $10,000.
“This may be the last straw for some of our clients,” said Ryan Marshall, a partner at Ela Financial Group, based in northern New Jersey. “One thing millionaire clients don’t like is paying taxes … When our clients retire, the number one question is whether or not they will live in New Jersey.”
If any of those clients live six months and a day outside the state, they can avoid paying state income tax.
Jeffrey Levine, director of advanced planning at Buckingham Wealth Partners, based in Short Hills, New Jersey, doesn’t expect a mass exodus of millionaires. “I don’t think an additional 2% is the thing that will make” New Jersey millionaires leave the state. “They will be upset and moan and groan but it won’t have a material impact.”
Academic studies on tax-led migrations of millionaires have reached differing conclusions. A 2019 Stanford University/Hoover Institution/NBER study about California’s 2012 tax hike on millionaire residents found that over 2% of those earning more than $2 million a year left after the tax hike was imposed compared to 1.2% before the hike took effect. But that 2% “millionaire tax flight” level is of only “marginal statistical and socioeconomic significance,” according to a 2016 report by researchers from Stanford University and the U.S. Treasury based on the tax returns of million-dollar earners nationwide.
“There will be a certain number of people that leave New Jersey and establish residency elsewhere because of this,” says Matt Masterson, a partner and wealth advisor at RegentAtlantic, which is based in New Jersey. “But what drives those decisions most is where your family lives — the kids and grandkids. Money is not the only factor.”
One important factor for where one lives has been job location, but that factor has declined in importance. Many people have been working from home because of the pandemic, and many will likely continue to do so even as companies reopen offices, so they can theoretically move outside the tri-state metro area, which includes New York state and Connecticut.
“It will be really interesting to watch over the next few years where high earners migrate to,” said Gorman, who’s based in San Francisco. “New Jersey is projecting $390 million now. It will be fascinating to see what they project three, four, five and 10 years from now.”
Tax Planning Tips
Gorman suggests that advisors working with high earners in New Jersey discuss where those clients want to live in the future. For corporate executives subject to the new tax, she suggests talking about deferring income to avoid triggering the tax and electing a 10-year payout so when they exit the state New Jersey can’t source it.
Some states like New Jersey and Pennsylvania have tax reciprocity agreements, so it’s important that taxpayers have “in-depth discussions with their tax and estate planners,” Gorman said.
Masterson recommends that New Jersey business owners, including those who live outside the state, consider using trusts to move those assets out of state in order to avoid state taxes when the business is sold. “But you have to do that well in advance of the sale,” he says.
New Jersey millionaire taxpayers may also want to convert traditional IRAs to Roth IRAs if they expect their tax bracket today is lower than it will be in the future.