Tax and Asset Protection Benefits Afforded Florida Domiciliaries
The most common reason an individual chooses to live in Florida is its temperate climate. But Florida’s benefits extend far beyond a warmer climate because of its favorable tax laws and asset protection opportunities. Since Florida does not impose an individual income, estate, gift, or generation-skipping transfer tax, and has very favorable asset protection laws, it is far superior than other states with respect to these matters of great concern to most people.
While Florida residents who want to avail themselves of asset protection may need to take steps to obtain those benefits, Florida residents can avail themselves of Florida’s beneficial tax laws without necessarily taking affirmative action (other than perfecting their Florida domicile). However, they must be mindful of lurking pitfalls if they own property in another state or if they spend significant amounts of time in another state, as they may then subject themselves to state income tax in that state during their lives and/or state estate tax upon their deaths.
Current Tax Law
An individual who is contemplating changing his or her domicile to Florida should consider doing so in 2010 because of the potential that tax laws may change. The federal estate tax exemption in 2009 is $3.5 million, but the future of the federal estate tax and the exemption amount is uncertain. Absent congressional action, the estate tax is scheduled to be repealed in 2010 and will be reinstated in 2011, but with a $1 million exemption. Many practitioners and commentators believe that Congress will take action in 2010, and that the federal estate tax exemption will remain at $3.5 million (at least until there is further reform) with a top tax rate of 45 percent. In addition to a federal estate tax, some states impose a state estate tax. In many cases, the state estate tax exemption is lower than the federal estate tax exemption, which can cause an unintended state estate tax to be payable, while other states, such as Florida, do not impose an estate tax.
Similar to the flux of the estate tax law, some state income tax rates will increase in this year. Because Florida does not impose an income tax, it is an attractive domicile for those who want to decrease their individual income tax liability. For individuals who are currently residing in a jurisdiction that has a city and/or state income tax (the combined effect of which can exceed 10 percent annually), as well as an estate tax (with tax rates approaching 16 percent in states such as New York), the tax cost of remaining a resident in that jurisdiction can be significant.
Under current law, individuals with adjusted gross income of $100,000 or less can convert from a traditional IRA to a Roth IRA. Effective January 1, 2010, there is no longer an income limitation imposed to take advantage of this conversion. When an individual converts to a Roth IRA, he or she will incur a federal income tax and, depending upon the state in which the individual lives at the time of the conversion, a state income tax. If an individual lives in a state that imposes an income tax, he or she should convert to a Roth IRA in the year after changing domicile, as the state income tax savings could be significant.
Advantageous Tax Laws
Florida is one of the few states that does not impose estate, inheritance, gift, income, intangibles, or generation-skipping transfer (GST) taxes. Most other states impose at least one, and more commonly several, of these taxes. For instance, New York and Vermont impose estate, income, and GST taxes; Connecticut and North Carolina impose estate, gift, and income taxes; Illinois imposes income and estate taxes; and Kansas imposes income, estate, and intangibles taxes. Some states, such as New Jersey, impose an inheritance tax in addition to the estate tax.
• Estate Taxes — As a result of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the state death tax credit that was applied against the federal estate tax for death taxes paid to a state was phased out. In 2005, it was replaced with a deduction against the federal estate tax. Prior to EGTRRA, Florida imposed a “pick-up estate tax,” such that the estate tax payable to Florida was equal to the state death tax credit. When the state death tax credit was phased out, Florida ceased to impose an estate tax.
Since Florida’s Constitution providesthat the state cannot impose an estate or inheritance tax that exceeds the amount allowed as a credit or a deduction against the estate tax imposed by the United States or by another state,1 Florida cannot impose an estate tax unless it amends its constitution or the state death tax credit is reinstated. It is highly unlikely that the people of the state of Florida would amend their constitution to institute an estate tax. Other states that do not have this constitutional restriction, such as New York, “decoupled” from the federal system and now impose an independent estate tax, which allows those states to continue to collect the tax dollars they would have otherwise sacrificed.
Although the estate of a Florida domiciliary will not be subject to a Florida estate tax, an unknowing Floridian may unintentionally subject his or her estate to an estate tax in another state. Real property and tangible personal property are generally subject to estate tax by the state in which the property is located, whereas intangible property, such as a security, is subject to estate tax by the state in which the decedent is domiciled.
If a Florida domiciliary owns real property in New York at the time of his or her death, the estate could be subject to a New York estate tax, even if the value of the New York property is less than New York’s $1 million estate tax exemption,2 which is significantly less than the current $3.5 million federal estate tax exemption. Because of this disparity, for example, if a Florida domiciliary has a taxable estate of $3.5 million comprised of $1.5 million of real property located in New York, his or her estate will not be subject to a federal estate tax, but will be subject to a New York estate tax.
Connecticut recently unified its estate tax exemption with the federal exemption. On January 1, Connecticut’s estate tax exemption became $3.5 million. Of course, the future of the federal estate tax exemption remains unknown. If Congress does not change the law as it currently exists, the federal estate tax exemption will remain repealed in 2010 and will be reinstated at $1 million in 2011. In that event, Connecticut’s estate tax exemption will exceed the federal exemption in 2011.
Individuals and their advisors should be aware of the estate tax exemption available in the state in which the individual owns real or tangible personal property and should also be aware that there are techniques that can be used to avoid the imposition of another state’s estate tax, two of which require the individual to give up control of his or her property. The individual could gift or sell the property to persons who would inherit the property upon the individual’s subsequent death. The individual’s advisor should consider whether a gift of the property will cause the imposition of a federal or state gift tax. If the individual sells the property, the sale terms should be similar to an arm’s length transaction between unrelated parties. Whether the individual gifts or sells the property, he or she must either relinquish the right to use the property or pay fair market rent to use the property in order to ensure that the value of the property is not included in the estate for estate tax purposes. It is important that there is no implied agreement between the donor and the donee whereby the donee agrees to allow the donor to retain the use and enjoyment of the property rent-free.
If the individual does not want to relinquish the right to use the property, he or she could contribute it to an entity, such as a limited liability company or limited partnership, which should convert the tangible personal property to intangible personal property. Intangible personal property is subject to state estate tax in the individual’s domicile state. The law of the state where the property is located should be analyzed to determine whether this technique will successfully convert the property from tangible to intangible property for estate tax purposes.
In New York, for example, the New York State Department of Taxation and Finance recently issued an advisory opinion3 to explain that, for estate tax purposes, a nonresident decedent’s interest in an S corporation or single-member limited liability company owning real property in New York state constitutes an intangible asset and is not included in the gross estate. In order to avoid estate taxation, however, the entity’s existence must be recognized for tax purposes, which means that its purpose is the equivalent of business activity. With respect to a single-member limited liability company, it must elect to be treated as a corporation under the “check-the-box” regulations in order to avoid New York state estate taxation. If it does not make this election, it will be treated as a disregarded entity, and the underlying property will be subject to New York state estate tax. In order to successfully assert that the entity has a business purpose, fair market value rent should be paid to the entity to use the property owned by the entity.
• Income Taxes — Florida’s Constitution also prohibits the imposition of an income tax.4 However, an individual who is domiciled in Florida could be subject to income tax in another state if he or she maintains certain connections to that state or spends a certain amount of time in that state.
For example, a Florida domiciliary who earns income generated from property located in New York or a business located in New York will be subject to New York income tax as a nonresident. Income from intangible personal property, such as dividends or interest, is considered New York source income to the extent the income is generated by property used in a business, trade, profession, or occupation carried on in New York.5 Beginning in May 2009, New York source income began to include certain gains or losses from the sale or exchange of an interest in a partnership, limited liability company, S corporation, and nonpublicly traded C corporation with 100 or fewer shareholders that owns real property in the state of New York.6 Some or all of the gain or loss from the sale or exchange of an interest in one of these entities will be considered to be derived from New York sources if the entity owns real property in New York that has a fair market value that equals or exceeds 50 percent of the fair market value of the assets the entity has owned for at least two years as of the date of the sale or exchange.7 If all of the entity’s assets have been owned for less than two years, the 50 percent test is met.8
An individual will be considered a New York “statutory” resident for income tax purposes if he or she spends more than the statutorily defined 183 days in New York and has an abode in New York.9 Spending even one minute in New York will count as a day unless the individual is traveling through New York to reach another destination or is required to stay in New York because of a medical emergency.10
New York and some other states have residency audit guidelines used by auditors to determine an individual’s domicile for income tax purposes. There is an agreement among various northeastern states in which the signatory states have agreed to apply uniform criteria to determine an individual’s domicile.11 New York auditors analyze two general categories — primary factors and other factors — when evaluating an individual’s domicile. If the auditor can make a determination based upon the primary factors, he will not even consider the “other” factors.
The five primary factors are as follows: 1) the home: the individual’s use and maintenance of a New York “residence” compared to the nature and use patterns of a non-New York residence; 2) active business involvement: the individual’s pattern of employment, as it relates to the compensation derived by the taxpayer in the particular year being reviewed; business involvement also includes active participation in a New York trade, business, occupation, or profession and/or substantial investment in, and management of, any New York closely held business such as a sole proprietorship, partnership, limited liability company, and corporation; 3) time: an analysis of where the individual spends time during the year; 4) items “near & dear”: the location of items which the individual holds “near and dear” to his or her heart, or those items with significant sentimental value, such as family heirlooms, works of art, collections of books, stamps, and coins, and personal items which enhance the quality of lifestyle; and 5) family connections.
No single primary factor is determinative. The auditor’s decision must be based upon a review of the first four primary factors, if possible; if not, then the fifth factor is considered. Moreover, the auditor is required to evaluate the primary factors objectively and to look at patterns that are established by the individual; the auditor is required to be open-minded and fair in evaluating all factors in a balanced and reasonable manner and must be cognizant of the fact that individuals go through evolutionary changes during their lives. When an analysis of the primary factors indicates by “clear and convincing” evidence that an individual is or is not a New York resident, the analysis is over. If not, then the “other” factors are considered.
The “other” factors are the traditional steps that an individual takes when changing domicile. Specifically, they are 1) the address at which bank statements, bills, financial data, and correspondence concerning other family business is primarily received; 2) the physical location of the safe deposit boxes used for family records and valuables; 3) location of auto, boat, and airplane registrations, as well as the individual’s personal driver’s or operator’s license; 4) indication as to where the taxpayer is registered to vote and an analysis of the exercise of said privilege; the auditor should not limit the review to the general elections in November, but also question the taxpayer’s participation in primary or other off-season elections, including school board and budget elections; 5) possession of a New York City Parking Tax exemption; 6) an analysis of telephone services at each residence including the nature of the listing, the type of service features, and the activity at the location; and 7) the citation in wills, testaments, and other legal documents that a particular location is to be considered the individual’s place of domicile.
To ensure that the Florida domiciliary will not be subject to New York income tax, care must be taken to 1) sever all ties to property that will generate New York source income; 2) spend no more than 183 days in the state of New York in each calendar year; and 3) act in a manner that will not subject him or her to treatment as a New York resident pursuant to the New York state residency audit guidelines.
• Gift Taxes — Florida does not impose a gift tax, while Connecticut and Tennessee do impose a gift tax. Prior to 2010, Connecticut’s gift tax was imposed on all gifts if the cumulative lifetime gifts exceeded $2 million. Beginning in 2010, Connecticut now imposes a gift tax on taxable gifts at a rate of 7.2 percent on the excess of gifts over $3.5 million (with no tax on taxable gifts below that amount) to $640,200, plus 12 percent of the excess of taxable gifts over $10.1 million, thereby reducing the present 16 percent top rate to 12 percent.12 Tennessee’s top gift tax rate is 16 percent13 and there is a $13,000 annual exclusion.14
• GST Taxes — Florida does not impose a GST tax, while Illinois, Massachusetts, Nebraska, New York, and Vermont do impose this tax. Each state’s statutes should be consulted to determine whether a GST tax will be imposed and whether there is, and the amount of, a state exemption. New York, for example, imposes a GST tax based upon federal tax law as it existed in 1998 and has a $1 million GST tax exemption.
• Intangibles Taxes — Beginning on January 1, 2007, Florida ceased to impose an intangibles tax. Other states (e.g., Kansas) may impose this tax.
Favorable Asset Protection Laws
Creditor protection has become increasingly important for many individuals. While some states extend some form of creditor protection to its residents, Florida law affords its residents a significant level of creditor protection. Individuals and their advisors should be aware that, in order to benefit from some aspects of creditor protection, affirmative steps may need to be taken.
• Homestead Property — Only a few states, Florida among them, exempt real property that is classified as homestead property from the claims of creditors. Florida’s homestead exemption statute15 protects the home of a Florida resident from forced sale in order to satisfy creditors.16
An individual must meet certain requirements and must take affirmative steps to qualify a home as homestead property. In order to be entitled to the homestead exemption, the debtor must 1) intend to permanently reside in Florida;17 2) have legal or beneficial title in equity to the real property on January 1; 3) reside on the property; and 4) in good faith make the property his or her permanent residence (or the permanent residence of others who are legally or naturally dependent upon such person).18
Florida law requires the residence to be owned by a natural person, not by an entity, such as a limited liability company. In general, if the homestead is owned by a revocable trust, for asset protection purposes, it should be treated as owned by a natural person.19
Homestead protection is subject to acreage limitations. If the residence is located in a municipality, homestead protection is limited to the extent of one-half acre. If the residence is located outside a municipality, homestead protection is limited to 160 contiguous acres. If, as a result of zoning changes, a residence is located in a municipality, the acreage limitation may not be reduced without the owner’s consent.
There are certain situations when homestead protection may be limited. A forced sale of homestead property will be permitted to enforce 1) payment of taxes and assessments thereon; 2) obligations contracted for the purchase, improvement, or repair thereon; or 3) obligations contracted for house, field, or other labor performed on the property.20 In addition, as a result of the Bankruptcy Act of 2005,21 §522(p)(1) of the Bankruptcy Code caps state homestead exemptions at $125,000 (now $136,875 due to inflation adjustment) for certain interests in real property that a debtor acquires within the 1,215-day (three years and four months) period immediately preceding his or her voluntary or involuntary bankruptcy petition.22
• Life Insurance Proceeds — Florida law provides that life insurance proceeds inure to the exclusive benefit of the beneficiary and are exempt from creditors of the insured unless the insurance policy or a valid assignment provides otherwise.23
• Cash Surrender Value and Annuities — F.S. §222.14 exempts from the reach of creditors the cash surrender value of life insurance policies insuring the life of a Florida resident and the proceeds of an annuity contract issued to a Florida resident.
• Retirement Benefits — F.S. §222.21 provides that money or other assets payable from a qualified retirement or profit-sharing plan are exempt from claims of creditors of the beneficiary and participant.
• Medical Savings Accounts and College Funds — F.S. §222.22 provides that assets set aside in a medical savings account, college trust fund, or plans established under §529 of the Internal Revenue Code of 1986, as amended, are also protected from creditors.
• Tenants by the Entireties Property — Tenants by the entireties is a form of ownership that only exists between husband and wife. Creditors of either the husband or wife cannot reach this property. In Florida, in order for creditors to attach property held as tenants by the entirety, the creditor must be a creditor of both the husband and wife.24 When the IRS is a creditor, the protection afforded property owned as tenants by the entirety may be limited.
Although Florida’s favorable tax laws and asset protection may not be an individual’s primary reason for moving to the sunshine state, those individuals who make the move learn quickly about the added benefits. However, in order to take full advantage of tax and asset protection laws, individuals must be sure that they are not inadvertently subject to estate or income tax in another state and that they properly qualify their homes for homestead protection. Because of the uncertainty surrounding the future of tax laws, it is critical for individuals who are considering changing their domicile to Florida to try to effect the change in 2010, if possible.
1 Fla. Const. art. VII, §5(a).
2 See Robert M. Arlen and David Pratt, The New York (and Other States) Death Tax Trap, 78 Fla. B. J. 55 (2003), for a discussion detailing how a New York estate tax can be payable if the value of the property located in New York is less than $1 million. A New York estate tax can also be payable when the value of the property located in New York is less than $1 million if the individual made taxable gifts during his or her life.
3 N.Y.S. Dep’t of Tax’n and Fin., TSB-A-08(1)M (Oct. 24, 2008).
4 Fla. Const. art. VII, §5(a).
5 N.Y. Tax Law §631 (McKinney 2009).
6 N.Y.S. Dep’t of Tax’n and Fin., TSB-M-09(5)I (May 5, 2009).
9 N.Y. Tax Law §605(b)(1)(B) (McKinney 2009).
10 N.Y. Comp. Codes R. & Regs. Tit. 20, §105.20(c) (2009).
11 The signature states to the North Eastern States Tax Officials Association Cooperative Agreement on Determination of Domicile dated October 1, 1996, are Connecticut, Delaware, District of Columbia, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, and Vermont.
12 Conn. Gen. Stat. Ann. §12-391(g)(2) (2009) (effective January 1, 2010).
13 Tenn. Code Ann. §67-8-106(b) (2009).
14 Id. at §67-8-104(c).
15 Fla. Const. art. X, §4.
16 Florida’s homestead law extends beyond asset protection. It also provides protection for descent and distribution purposes and property tax purposes. This article addresses homestead protection for asset protection purposes.
17 Fla. Stat. §196.015 (2009).
18 Fla. Stat. §196.031(1) (2009).
19 See In re Alexander, 346 B.R. 546 (Bankr. M.D. Fla. 2006); In re Edwards, 356 B.R. 807 (Bankr. M.D. Fla. 2006); Callava v. Feinberg, 864 So. 2d 429 (Fla. 3d D.C.A. 2003); but see In re Bosonetto, 271 B.R. 403 (Bankr. M.D. Fla. 2001).
20 Fla. Const. art. X, §4. See also In re McFadyen, 216 B.R. 1006 (Bankr. M.D. Fla. 1998).
21 Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L. No. 109-8, 119 Stat. 23 (2005).
22 11 U.S.C. §522(p)(1). The limitation set forth in §522(p)(1) applies to 1) real or personal property that the debtor or the debtor’s dependent uses as a residence; 2) an interest in a cooperative that owns property that the debtor or the debtor’s dependent uses as a residence; 3) a burial plot for the debtor or debtor’s dependent; and 4) real or personal property that the debtor or debtor’s dependent claims as a homestead.
23 Fla. Stat. §222.13 (2009).
24 In re Davis, 403 B.R. 914 (Bankr. M.D. Fla. 2009).
David Pratt is a partner in Proskauer’s personal planning department and is the managing partner of its Boca Raton office. Mr. Pratt specializes in estate and gift, generation-skipping transfer, and fiduciary income taxation. He is a fellow of the American College of Trust and Estate Counsel and is Florida board certified in taxation and wills, trusts, and estates.
Lisa Stern is a senior counsel in Proskauer’s personal planning department and works in its New York City office. Ms. Stern also practices in the areas of estate and gift, generation-skipping transfer, and fiduciary income taxation, as well as fiduciary litigation.
This column is submitted on behalf of the Tax Section, Frances D. McCoid Sheehy, chair, and Michael D. Miller and Benjamin Jablow, editors.