Proving Your Residence: More Important after Estate Tax Reform

Some states will go to extraordinary lengths to keep from losing you as a legal resident.

Unfortunately, that’s not a good thing. They aren’t going to heap inducements and incentives on you as they do to entice companies to stay. Instead, sometime after you think you’ve moved, they’ll argue that you or your estate still are subject to their taxes.

There are two times when states are likely to challenge your residence. One is shortly after you think you’ve moved. They’ll argue you still owe their income taxes and perhaps other levies. The other time is
after you pass away. The 20 or so states that retain estate and inheritance taxes want to impose them on your assets.

Tax reform added another reason why establishing your residence should be an important part of estate and income tax planning. Now, deductions for state and local taxes are limited to $10,000 annually.
You won’t receive offsetting federal tax deductions when your total state and local taxes exceed $10,000, so a high state and local tax bill costs you more money than it used to.

States aren’t the only governments that are aggressive on this issue. Some cities and counties have high local taxes, and they try to retain as many of those taxes as possible, whether someone moved across the country or the state.

States have different levels of aggressiveness in assessing taxes against people who’ve moved. A good general rule is that the higher the taxes a government imposes, the more likely it is to challenge changes of residence.

You aren’t safe even when one of the states involved does not have an income or estate tax. States often impose their own sales and use taxes on all the purchases by their residents, and a state might claim
someone is still a resident so it can collect those taxes on major purchases.

If you moved or if you regularly spend time in two or more states, proving residence needs to be part of your plan.

Some states tax “residents.” Others tax “domiciles.” The two terms have different legal meanings. To complicate matters, each state can write its own definition.

Your job is easier when a state has a hard line rule. The most common of these rules holds that anyone who spends more than 183 days in the state (i.e. more than half the year) is a full-time resident of the
state. The state imposes its income tax on all income, sales tax on all purchases and estate tax on all personal property owned by a full-time resident. Spend less than 183 days in the state and taxes are imposed only on income earned in the state. Sales taxes are imposed only on purchases in that state,
and estate taxes are due only on real estate located in the state.

Other states, usually those that tax based on domicile, have a more subjective standard. In general, a domicile is the place a person intended to keep his permanent residence or abode indefinitely. Short-term trips don’t change a person’s domicile. Even a multi-year absence doesn’t change domicile
if there wasn’t an intention to abandon permanently the original domicile.

Because the definition is subjective, the states will look at a range of activities and decide the individual’s intentions from those actions.

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.

Taxpayers can protect themselves and their heirs from this trap.

Documentation is the key. You have to compile evidence that proves you really changed your residence or domicile. This should be a critical part of your estate plan, if you spend a lot of time in more than one state or moved late in life after living in one state for at least a few years. Most estate
planning lawyers are well-versed in how to prove a person’s residence or domicile.

Know the rules. There is no substitute for learning the definition used by each state with which you have contacts. If a state uses the 183-day rule, you know how to establish the tax status you want in that
state. For the states that are more subjective, get a list of the factors each will consider. Some states list the factors in their tax codes. Others have had the factors developed by court decisions and regulations.
A tax or estate planning expert should be able to provide you with a complete list. The members’ section of our website, in the Checklists contained in the Members’ Extras section, has a list of factors used by
most states.

Count days. No matter which rule a state uses, the days spent in each location are important. Keep records of where you spend each day. You can keep a journal, make notations on a calendar, or use some
other method. Even this can get tricky. Some states say any part of a day spent in their borders counts as a full day, especially if you spent money in the state. Others do not count travel days and partial days.

Show your intent. States with a subjective test often require you to completely sever ties with them to avoid their taxes. They look at what are called contacts with the state. The more contacts you have,
the greater the likelihood that you’ll be viewed as a resident. Your driver’s license, auto registrations, voter registration and church and club memberships all must be changed. For example, a state might not
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.

Real estate and business interests can cause significant problems.

To minimize risk, you need to sell all residences in a state. Some states say if you maintain an abode to which you can return, you never intended to permanently leave, even if you rent it to others. If you
want a place to return to in a state, at a minimum you should downsize. Sell the old place and buy a smaller one. Or rent a new place instead of owning a property. But even these measures have risks in an
aggressive state.

States that use a subjective test generally say that if you remain actively involved in a business there, you haven’t left the state. To leave these states, you have to sell the business or at least become a passive investor. It also is not a good idea to leave behind valuable items such as jewelry, furs and art.
Many states consider that leaving valuable items, even in storage, is a significant contact that triggers taxation.

Don’t play games. Don’t leave gray areas or inconsistencies that allow a state to assert you are resident there. 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.

Some tax departments are more aggressive than ever, especially in states that are losing residents. With lower federal taxes, state levies are relatively more significant than they used to be. Don’t give a state an
incentive to troll through your telephone, credit card and other records. Let the state auditors believe their time is better spent elsewhere by clearly establishing you definitely moved.