Proving your state of residence or domicile became more important in 2020, and the importance will grow in 2021 and beyond.
Many workers transitioned to re-mote employment during the pandemic, toiling from home or some location other than their employer’s facilities. Initial indications are that remote working will be common-place after the pandemic, though perhaps not as much as during the pandemic.
Also, a previous trend continues of people moving from high-tax states to lower-taxed states. That trend accelerated when the 2017 Tax Cuts and Jobs Act limited federal income tax deductions for state and local taxes to $10,000 per year, and the pandemic seems to have further accelerated the trend. Someone who is still working generally is taxed in his or her state of residence or domicile, but income earned in another state also might be taxed in that state.
A retiree generally is taxed on all income in the state of residence or domicile.Many states saw their tax revenue decline in 2020, and others have had their revenue decline over the long term because of residents and businesses moving to other states.
These states aggressively are seeking to tax as many people as they can.
In the future, the Supreme Court or Congress is likely to decide the extent to which a state can tax the employment or self-employment income of someone who lives in one state and works from home but works for a business headquartered in another state. Several states are claiming they can tax earned income of people who used to commute into their states to work but now are working remotely from other states.
One aggressive state action that will continue, and probably be more frequent, is to claim that people who think they’ve moved to another state haven’t officially moved. They’re still subject to income, estate and even sales taxes in the states as residents or domiciles of the state they thought they left.If you’ve moved, or are planning to move, especially from a higher-tax state, it is important to be able to prove legally that you moved. A routine tool of some state tax departments is the residency audit.
When the state sees that someone who used to file an income tax return as a full-time resident now files as a part-time resident or doesn’t file at all, the state takes a look. The high-er-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.
In any of these cases, a state seeks to prove the person still is a fully taxable legal resident of that state. Tax and estate planners say they have seen an increase over the years in residency audits.You have to plan a lot of things when moving.
Among them, especially if you are a high-income or high-net-worth taxpayer, is to be able to prove that you legally established your residence or domicile in the new state.It is best to prepare for a residency audit while you’re moving, and even before starting the move.
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.
Plan your move and accumulate your documentation with a potential residency audit in mind. Don’t go into a residency audit unprepared or without professional help.
Your defense is to show that you severed all or most ties with the old state and made major changes in your lifestyle.
Your life needs to be centered around the new state.You first should learn what your old state’s rule is for taxing people.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 could be counted as being in the state when you thought you weren’t near it.
You should maintain logs or calendars that list where you were each day of the year. Also, keep receipts that can prove what is in the logs or calendars.
Be aware of how technology tracks you and leaves a record of your locations during the year. The aggressive states often review cell phone records and other technology trails.
Other states impose taxes based on a person’s domicile, which is a more subjective test. A domicile is the place a person intended to maintain a permanent residence or abode indefinitely. The state looks at the facts and circumstances to determine your intention.
The domicile review starts with the 183-day rule, but that is only the beginning. Under the domicile standard, 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 is acceptable to downsize and maintain a smaller home in the old state, but that carries risks. The safest route is to not own or even rent 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 all other contacts 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, nonresident or associate status instead of being resigned or transferred.
They’ll argue the change is temporary and you easily can switch back to full or resident membership. Some states also expect you to give up professional licenses in their states or at least obtain new ones in the new state.
It also is not a good idea to leave valuable property such as jewelry, furs or art in the old state. Many states consider leaving valuable items, even in storage, as 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 or she 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 that same state you are resident elsewhere. In other words, be sure all your actions are consistent with each other and with the idea that you made a permanent move. An aggressive state will look at these and other actions and pounce on inconsistencies.
Inconsistent actions could trigger fraud penalties in addition to a tax bill.
Another reason to carefully document your move is that, since states have different rules and interests, 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.
For some states, the big payoff is from their estate or inheritance taxes. When you no longer are around to testify and help gather evidence, the states can swoop in and assert their claims against your estate.States aren’t your only concern.
Some cities and counties use the same tactics to retain tax dollars.
To help make your case, there’s a checklist of factors used by most states in the Members’ Extras section of our website.