The Tax Cuts and Jobs Act slashed deductions for state and local taxes, and that’s causing many higher-income people to move to states with lower tax burdens.
The higher-tax states aren’t idly accepting this situation. The residency audit is becoming more frequent. This is when a state tax agency tries to prove that someone still is a legal resident of their state and must pay taxes on all their income.
High-tax states have pursued taxes from former residents for years, but they increased their efforts following the 2017 tax law. Income taxes aren’t the only motive for residence audits. Some states conduct them to impose estate taxes or sales taxes.
When you move from one state to another, take care that you legally establish the new state as your legal residence. States don’t report the number of residency audits they conduct, but tax professionals say the number has been increasing. The higher the income you reported to your high-tax former state of residence, the more likely you are to be audited after reporting a change of residence.
States closely examine tax returns that claim nonresident or part-year resident status. The higher tax states also aggressively search property records and other public records for signs that someone who no longer is filing a tax return as a full-time resident has significant contacts with the state.
If you receive a letter from a state tax authority raising questions about your residence status, you should assume the state already conducted a lot of research into your situation. The letter might be accompanied by a questionnaire or a request for an interview, or both.
You need to show that you severed all or most ties with the old state and made major changes in your lifestyle.
When you move, assume you’ll be subject to a residence audit. Plan your move and accumulate your documentation with a potential audit in mind. Don’t go into a residence audit unprepared or without professional help.
Some states have a bright line rule. If you’re in the state for more than 183 days in the calendar year, then you’re a full-time resident. Spend fewer than 183 days in the state and you’ll only be taxed on income earned in the state.
Be careful about getting too close to the 183-day threshold. States have different rules for counting travel days and other days when you’re in the state only part of the day. You should maintain logs or calendars that list where you were each day of the year. Also, keep receipts that can prove your travels during the year.
Be aware of how technology tracks you and leaves a record of your location during the year. The state often reviews cell phone records and other technology trails.
Other states impose taxes based on a person’s domicile, which is the place a person intends to maintain a permanent residence or abode indefinitely. The state looks at the facts and circum-stances to determine your intention.
This review starts with the 183-day rule, but that’s only the beginning. Under the domicile rule, you can spend only a few (or even zero) days in a state during the year and still be considered domiciled there when other facts don’t show you intended to leave permanently. The biggest mistakes are to continue owning a home or business in the old state. Sometimes it’s acceptable to downsize and maintain a smaller home in the old state. The safest route is to not own a home you can return to in the old state or a business in which you are more than a passive investor.
As much as you can, sever other contact with the old state. The more contacts you maintain, the greater the likelihood that you’ll be viewed as a domicile or resident. Your driver’s license, auto registrations, voter registration and church and club memberships all should be changed. Most states won’t consider the move permanent if memberships are switched to inactive or associate status instead of being resigned or transferred. Some states also expect you to give up professional licenses in their states or at least obtain ones in the new state.
It also is not a good idea to leave behind valuable property such as jewelry, furs and art. Many states consider leaving valuable items, even in storage, a significant contact that triggers taxation.
A common mistake is to keep a boat or vehicle registered in the old state because the property taxes or registration fees are lower. Another frequent mistake is for someone to tell the state he is a passive investor in a business but assert active investor status on the federal income tax return, where it can result in big tax savings.
Another bad ploy: Tell an insurance company you are resident in one state because premiums are lower for its residents but tell the state you are resident elsewhere. An aggressive state will look at these and other documents and pounce on inconsistencies. These actions could trigger fraud penalties in addition to a tax bill.
You can see how, with these different rules, it is possible for two or even three states to argue that an individual or estate is fully taxable by each.
Perhaps worst of all, a state can spring this trap after you have passed. The big payoff for many states is its estate or inheritance tax. When you no longer are around to testify and help gather evidence, the states can swoop in and assert their claims against your estate.
Some cities and counties use the same tactics to retain tax dollars of those who move around the state or out of state.
The members’ section of our website, in the Checklists contained in the Members’ Extras section, has a list of factors used by most states.