The Corrosive Effect of High State Income Tax on the High Income Earning Family

 

One of the joys of making more money is paying more taxes. Before someone chimes in and tells me what a good problem this is – yes, I get it. We are fortunate to make a lot of money and therefore pay a lot of taxes. It beats the alternative. Now with that out of the way, let’s look at today’s topic: the corrosive effect of high state income tax on the high income earning family.

We paid $44,000 in state income tax in 2015 (pre-partner for me at my group) and $58,000 in 2016 (partner for half of the year). I anticipate we will pay greater than $60,000 per year moving forward. To date, this has been offset somewhat by a federal deduction for state income tax for those who itemize their deductions (most of my readers, I would imagine). In 2016, this deduction was by far our largest and worth:

$58,000 x 0.39 (highest fed. tax bracket) = $22,620

This deduction effectively reduces the state income tax for high earners in high income states by 39%. This may be changing soon. Recent discussion of tax reform centers on eliminating the federal deduction for state and local income tax.

I decided to look at the true cost of living in a high income tax state like mine. For simplicity, I will imagine that our state income tax moving forward remains constant at $60,000 per year and that our alternative is living in a state with no tax on wages  (Alaska, Florida, Nevada, South Dakota, Texas, Washington, Wyoming, Tennessee, New Hampshire). I will also assume that tax reform passes and the state tax deduction is eliminated. Of course, this is all overly simplistic to some extent because states with no state income tax tend to have higher property and sales tax. We also may earn more money moving forward so it may in fact be overly conservative.

So let’s say we moved to one of these states and now had $60,000 extra in post tax income to invest in VTSAX earning a conservative annual return of 6%. Where does that leave us after our 25 year careers are up? Here we have it:

Ouch.

Now there are a lot of assumptions at play here, as I alluded to earlier. I am assuming:

  • we would take this extra take home income and be disciplined enough to invest all of it and not grow our lifestyle
  • our savings on state income tax would not be significantly offset by extra costs paid in sales tax or higher property tax, or perhaps even private school.

For high earning couples early in their career and residing in a high income tax state like my wife and I, it is worth considering how strongly you feel about living in one of these states. Naively, we didn’t really run the numbers or consider how much state income taxes would cost us when we were interviewing for our first attending jobs out of residency. Now we are very settled where we live and we have our reasons for loving it here – a great job as a partner in my specialty group; living in a nice part of the country with reasonable weather, limitless outdoor activities, and excellent public schools; family close by. If you don’t have these things tying you to your area (and particularly if the proposed tax reform passes), it may be worth considering a move earlier in your career than later.

 

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Readers, what are your thoughts?

8 Replies to “The Corrosive Effect of High State Income Tax on the High Income Earning Family”

  1. Very well laid out. I contemplate this all the time because living in New York City isn’t short of expensive-anything.

    I’d be curious to get your thoughts about the same high-paying job in a lower cost state, does your exist?

    I think about moving 1 hr 45 mins south to Philadelphia, but my specialty simply doesn’t exist there. If I choose to live in Philly and keep my NYC job the commute would catch up with me. In reality, I’d have to ditch my speciality and go back to general Finance.

    Lots of self-reflection about when is enough, enough. Great post.

    1. Thanks for reading! One of the nice things about medicine is that we have a lot of employment options. We could each get jobs in probably any of those states for the same or more than we make now. Now, whether we would be happy living in all of those states or comfortable sending our kids to public school in all of those states is another question.

      NYC is the greatest city on earth so I can see your dilemma. We have even talked about spending half of the year or so in NY when we are retired (if we can afford to).

  2. Were you subject to the AMT? If so, you might not get the benefit of deducting your state income tax paid. I pay half what you do in state income tax, but I’ve paid the AMT every year, losing out on the benefit of the deduction I thought I’d be getting.

    The fact remains that we’d be better off financially in low or no state income tax states. But there’s more to life than money, and where you live can have an immense impact on happiness, since relationships with friends and family are key components of what brings us joy.

    Cheers!
    -PoF

    1. Hey PoF. We were subject to about $1,500 worth of AMT (curiously, much less than the year before when we made less). But the way I read my tax return, I still keep my itemized deductions (including the $60,000 plus deduction for state income tax) and the AMT is just added on to the taxes due after my itemized deductions. It definitely didn’t offset the state income tax deduction last year.

  3. I feel your pain. I also live in a state with high income tax. It is what it is as there really is zero chance that my wife and I would move. We just try to minimize taxes where we can by taking full advantage of our tax-deferred accounts.

  4. As California residents in a dual physician household, your post is timely and resonant. We have comparable situations – partner in a private group I feel lucky to be a part of, physician wife, kids, pricey home owned in a HCOL state.

    Like your financial advisor, I’m extremely impressed with how quickly you’ve moved from your negative net worth to just broke in the past 3 years – a testament to your discipline.

    If you can stave off the lifestyle inflation and continue to save aggressively for a few more years, you may buy considerable freedom on the back end.

    The only statement to give me pause is your projected 25 year career – as PoF has modeled, this career timeline may grow compelling in light of the opportunity costs after a solid decade in practice, so the closer you get to FI the more autonomy and flexibility you’ll be able to exert when you most desire it (and fewer of your peers can afford it).

    Here’s to your auspicious debut as a new voice among docs in finance!

    Fondly,

    CD

  5. Crispy Doc, thanks for the very kind comments. I enjoyed your blog as well and will follow along! I agree that keeping the flexibility to go part-time or retire early is one of the most important reasons to maintain a high savings rate. Thanks again.

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