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Key Steps to Take Before a State Tax Audit

Last update on: Nov 09 2017
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The most important tax audit of your life is likely to take place either in the first few years of retirement or after you pass away. It is a state residency audit and could befall anyone who moved to another state during retirement or who owns homes in at least two states during retirement.

A number of low tax states are marketing themselves to retirees who are seeking to reduce their expense by cutting state taxes. One study found that about 1,000 Americans per day move from states with income taxes to states with no income taxes. The higher-tax states are fighting back with residency audits of former residents. They are aggressively targeting individuals who claim to have changed their residences but retained significant contacts with their old states.

The residency audit is likely to occur at either of two times. One point is shortly after you stop filing income tax returns in the old state or start filing part-year resident returns after years of filing full-time resident returns. The other point is after death.

Income taxes are not the only target of the states. While the federal government has been reducing estate taxes, about half the states have kept estate or inheritance taxes in place. These taxes often have lower thresholds than the federal estate taxes and can be much more significant than the federal taxes.

New York and California are the most aggressive in challenging residence status, but other states are active.

The problem for individuals is that residence and domicile are nebulous, complicated concepts. The rules and decisions often vary between the states and are reviewed only by their own courts. The states do not have to make consistent decisions. It is not unheard of for two states each to claim one person as a resident.

Most states have one bright-line rule. If you are present in the state more than 183 days (half the year) you are a full-time resident. The first step if you want to change residence is to keep a log or other proof showing that you were physically present in the new state more than 183 days of the year, or at least that you were not in the old state more than 183 days.

While being in a state more than 183 days makes you a resident, being out of the state more than 183 days does not automatically make you nonresident. Contacts with a state and other subjective factors can determine your residence.

Residency and domicile are defined as states of mind. A person is resident in the state he intends to be his permanent residence indefinitely. Facts and circumstances are used to determine a person’s intent. You need to line up as many facts as possible to demonstrate your intent to change residence. Establishing the facts is important, because you won’t be around to help in an estate tax audit.

Here are key steps to take.

  • Change any government registration or official address. Change the address for your passport, driver’s license, voter registration, and auto registration. File all federal, state, and local tax returns with the new address and file them with the office that is designated for residents at your new address.
  • Have all your financial accounts sent to the new address. These include bank accounts, brokerage and mutual fund accounts, credit card statements, and other loan statements.
  • Have all your mail sent to the new address. When you spend time at the other home, have mail held or forwarded only temporarily; do not register a change of mailing address with the post office.
  • If you travel a lot, whether between multiple homes or on vacation, keep a log or diary of the travels. Leave for vacations from the new permanent residence.
  • Execute a new will in the new state.
  • Shift memberships in clubs, churches, and other organizations to the new state. Drop memberships in the old state or change them to associate, non-resident, or some other part-time status.
  • Sever fixed contacts with the old state. Most advisors believe it is best to sell the residence in the old state or rent it full time so that you are not able to stay there. If you want to maintain some kind of residence in the old state, downsize and do not leave personal items that indicate an intent to stay there, such as photos. Also, do not leave valuables or personal items in the old state. Some people leave their important documents, jewelry, and other items in storage or safe deposit boxes in the old state. That shows an intent not to leave permanently.
  • If you maintain a residence of some sort in the old state, have all bills sent to the new state and conduct any correspondence using the new address.
  • Keep the evidence of your intent to move. In an audit, the state might ask for diaries and calendars, credit card statements, phone bills, and other information for three years. Make sure your heirs and executor know where this information is.

 

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