In today’s world, it is more and more common to relocate on either a temporary or permanent basis.
Whether it is for a sought-after change such as a dream job in another state or a post-retirement move to a warmer climate, or for reasons less opportune – military service, serious illness, or divorce – don’t let an unintended impact of relocation be an unanticipated state tax bill with multiple states claiming to be your state of residence and attempting to tax your income.
Increasingly, states are challenging former residents who attempt to change their domicile to another state. Residency audits are on the rise, particularly in states where larger numbers of residents are more likely to spend winters elsewhere.
Although the rules vary among states, generally speaking, most states define a “resident" as an individual who is in the state for other than a temporary or transitory purpose. States consider a person’s “domicile" to be the place of his or her permanent home to which he or she intends to return to whenever absent from the state for a period of time. Most claim the right to tax an individual’s income if they are believed to be a resident and domiciled in that state. Usually, they also impose tax on 100 percent of a resident’s income from all sources, including portfolio income. Many states have exceptions for military personnel in active service and for individuals receiving medical treatment for an extended period of time.
Individuals who could be caught in the trap of dual residency and dual taxation are retirees with a second home in another state, taxpayers who live in one state but have business activities or interests in another state, individuals who have relocated to another state but return after a number of years, individuals who temporarily relocate to another state or overseas for a job assignment, and individuals who have severed all ties with a state but fail to establish residency or domicile in another state.
Typical factors states use to determine residency
Often, a major determinant of an individual’s status as a resident for income tax purposes is whether he or she is domiciled or maintains an abode in the state and are “present" in the state for 183 days or more (one-half of the tax year). Minnesota’s current budget bill proposes lowering the residency threshold from 183 days to 60 days for individuals who maintain a residence in Minnesota but live part of the year elsewhere. California and New York are particularly aggressive in this respect. There and elsewhere, taxpayers have the burden of proving through documentary evidence which states they spend time in during the year and how long they remain in these states.
Other evidence often considered in evaluating whether there has been a permanent change in domicile includes:
- Location of employment
- Classification of employment as permanent or temporary
- Location of business relationships and transactions, such as active participation in a profession or trade or substantial investment in or management of a closely held business
- Serving on the board of directors for a business or charity
- Living quarters—whether a person’s former living quarters were sold, rented out, or retained, and whether he or she leased or purchased real property in his or her new location
- The amount of time spent in the state versus amount of time spent outside the state (183-day rule)
- State where the taxpayer is registered to vote
- The state of issuance of a driver’s license or fishing/hunting permits
- Location of the school a family’s child attends
- Memberships in country clubs, social, or fraternal organizations
In residency audits, state auditors will review:
- Credit card statements—where charges are incurred, where the bill is sent, and the location of the checking account used to pay the bill
- Location of bank accounts, investments, and other financial transactions such as automated teller machine withdrawals
- Resident and nonresident fishing/hunting licenses and park admissions
- Freeway fast-lane pass charges
- Records of airline frequent-flier miles
- Jurisdiction issuing a driver’s license, vehicle registration, professional license, or union membership
- Homestead tax abatement or credit applications and property tax bills
- Church attendance and membership
- Location of doctors, dentists, accountants, and attorneys
- Official mailing address and where mail is received
- Where an individual is registered to, and actually does, vote
If you live elsewhere but travel on a regular and frequent basis to another state, it is a good idea to maintain a diary that clearly indicates the dates on which you are in a specific state, accompanied by supporting records such as transportation tickets and receipts.
Note that the allowable level of participation in charities and social organizations varies among states. Some states like Wisconsin do not count such participation against taxpayers claiming nonresident status.
Action steps to take when changing your residence
Changing one’s residence takes planning and is a proactive process. While courts consider taxpayer intent in state residency disputes, they ultimately look to documents and facts to decide where the state of domicile is.
Careful documentation is key:
- Note the date of your change of residence
- Document in writing the reason for the change in residence which shows basis and intent (i.e., permanent retirement and relocation)
- Obtain a driver’s license in your new state
- Register your vehicle in your new state
- File a resident income tax return in your new state
- Revoke any homestead claims or election on your home in your former state and file similar documents in your new state of residence
- Register to vote in your new state
- Open bank or brokerage accounts in your new state
- Replace involvement with business, charities, and other organizations in your former location with activity in such organizations in your new residence
- Change the mailing address for all bills, banks, insurance, doctors, etc. to your new state address
- Keep a calendar of when you are in your former state versus when in your new state or states
- Retain airplane tickets, credit card statements, hotel records, etc. that will support your calendar
- Change professional licenses to your new state (if applicable)
- Establish relationships with new doctors, dentists, accountants, attorneys, etc.
If you have previously filed a tax return in your current state but are changing your residence, it is imperative that you closely observe the formalities of making a change of residence and that you retain all documentation you may need to prove your new residency. State tax law generally holds that you are not deemed to have created a new domicile until you have abandoned your former state of residence. In addition, be sure to keep that documentation until your former state’s statute of limitations permitting them to audit a return runs its course.
Changing domiciles while continuing to be actively involved with a closely held company is especially complicated. It can be done with proper planning. However, a portion of the compensation earned or profits from a "pass-through" entity (e.g., S corporation) will remain taxable by the state or states in which business is conducted or services are rendered by the owner to his or her company.
There are many documented cases of states successfully asserting tax claims on former residents’ income. In some instances, this has occurred years after the individuals moved to another state or took a job overseas and returned to the US. When changing your residence, be sure you consult with a tax professional so that you understand the benefits (such as lower tax rates) as well as the potential pitfalls. Don’t pay state tax on more than 100 percent of your income.