State Tax Quirks
Some of the most overlooked aspects of tax occur at the state level.
Currently, I am enrolled in the Tax Planning Certified Professional™ (TPCP™) program. For any of my advisor friends that are subscribed here, it has been absolutely incredible. It pairs incredibly well with the CFP® Exam coursework.
While the course focuses on taxes at the federal level, there have been some items that come up with nuanced state level differences. While the course doesn’t cover too much for specific states, it does highlight that it is possible, which usually leads me down a rabbit hole of finding new items to focus on.
Some of these state level differences are actually really interesting and could potentially impact a decent amount of people!
Today, I wanted to outline just a few. Trust me, there are more than the 4 I am going to outline.
HSAs
You’ve probably seen someone say that HSAs are triple-tax advantaged. In most cases, they are! But certain states may play by different rules.
New Jersey and California do not conform to the federal guidance. In each of these states, the contributions are taxable at the state level.
To throw a massive administrative burden on HSA owners in these states, interest and dividends can be subject to state tax as well on an annual basis. While it is still federally tax-advantaged, the state level taxation can be tough to keep track of.
529 -> Roth Rollover
The Secure Act 2.0 gave 529 savers an amazing way to distribute funds to their beneficiary in the event they overfunded the education savings plan. 529 Plans are eligible to rollover up to $35,000 (lifetime limit, but subject to Roth contribution limit annually) to beneficiaries assuming the beneficiary has been named for over 15 years and has earned income.
This is an awesome generational planning tool. However, there are a slew of states that do not conform to the federal guidance here as well.
The rollover is permitted, but there may be a state tax recapture to the extent contributions were deducted.
Remember, some states offer a deduction for contributing to the 529 Plan. When the 529 to Roth rollover occurs, some states are looking to recapture that deduction.
My California friends… CA is arguably the least favorable state for a 529 to Roth rollover to occur. They recognize tax on the earnings and the rollover can even be subject the rollover to an additional 2.5% penalty for a non-qualified distribution.
Capital Losses
Generally speaking, capital losses can be carried forward indefinitely. Meaning that if someone does not take full advantage of them in the year they are recognized, they can be used the year after.
However, for our NJ and PA friends, that is not the case. These states do not recognize carry forward losses at the state level.
A huge planning item for people in these states! Especially for NJ as NJ state tax can range up to 10.75%!
As I continue my journey in this profession, it has become more clear to me that simply understanding these nuances and quirks can allow for so much opportunity. We don’t necessarily need to know which stock to pick or which sector is going to perform well, but understanding how to keep more of our hard earned dollars by way of tax knowledge can take a lot of guesswork out of the equation.
The takeaway here is to be aware of the potential differences at the state level. For some, these differences can make a significant difference in their financial lives!
Again, these are just a few examples of how state level taxation may differ from the federal rules. There are many more and some that carry significant weight, such as estate taxes!
This is for informational purposes only and is not intended as legal, tax, or investment advice or a recommendation of any particular security or strategy. The investment strategy and themes discussed herein may be unsuitable for investors depending on their specific investment objectives and financial situation. Opinions expressed in this commentary reflect subjective judgments of the author based on conditions at the time of publication and are subject to change without notice. Past performance is not indicative of future results.