Why and How to Prove Your Legal Residence and Minimize Estate Taxes

Many states don’t like when people leave theri residence to live in other states. It’s nothing personal. The state governments need your tax dollars, and some states will do anything they can do retain as much of your taxes as they can. A state won’t stop you from physically leaving, but it will argue that legally you haven’t left, and that could cost you or your estate a lot of money.

New York is one of the most aggressive at trying to hold on to its residents. In a recent case, a New York lawyer retired from his practice and moved to Florida. But he did some legal work now and then. He didn’t apply for a Florida bar license. Instead, when he had to appear in court for one case, the court granted him special permission to provide legal services in that case. This happens regularly when a client wants to use a lawyer who isn’t licensed in the state and who doesn’t plan to practice law regularly in that state.

But New York tried to tax the lawyer’s income. The state argued that the lawyer was granted permission to appear in the Florida case because his New York bar license indicated he was qualified. Without his New York license, he wouldn’t have received the exemption. Therefore, the state said, the income was attributable to a profession carried out in New York.

Fortunately, the case was thrown out, and the lawyer didn’t have to pay New York state tax. This is an example, however, of how far some states will go to retain taxing authority over a person or an estate. The aggressive states, such as New York, conduct residence audits of many people who move, especially those who move to no-tax states. The problem is so big that the late comedian Joan Rivers stated in her will where she considered herself to be resident and domiciled.

You don’t want to be, or leave your estate as, the target of taxes and probate fees from two or more states. Your old state might assert that you never legally left and are subject to income and estate taxes and probate as though you were a full-time resident. Or if you spend part of the year in a second state, such as at a winter or summer home, both each state might argue that you are a full-time resident there.  Without careful planning a person can be subject to two states claiming him or her as a full-time resident. You aren’t safe if one of the states involved does not have an income or estate tax. Sales and use taxes are charged on all the purchases of residents of a state, even if the purchases are made in another state. Buy a car or boat outside your home state, and both states might say you owe sales or use taxes.

Note: This issue can apply even if you don’t move out of state. Some cities and counties use the same tactics to retain tax dollars of those who move around the state.

When you spend time in more than one state or move from one state to another, especially from a high-tax state to a low-tax state, you have to amass the evidence to prove that you really changed your residence or domicile, whichever concepts the relevant states use. Establishing a legal residence should be part of your estate plan, and most Estate Planning lawyers are well-versed in how to prove a person’s state of residence or domicile.

Some states tax residents. Others tax domiciles. The two terms are different legally. To complicate matters, each state defines the terms its own way.

Your status is certain when a state uses 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 property in that state.

Other states, usually those that use domicile, have a more subjective standard. In general, a domicile is the place a person intended to make his permanent residence or abode indefinitely. Short-term trips don’t change a person’s domicile. Even an extended absence doesn’t change the domicile if there wasn’t an intention to abandon 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 conclude that an individual is fully taxable by each.

Perhaps worst of all, a state can spring this trap after you are gone. The big pay off 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.

Know the rules. There is no substitute for learning how each state with which you have contacts defines residence or domicile. 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 web site, in the Checklists contained in the 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 an important factor. 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 the day spent there counts as a full day, especially if you spent money in the state. Others do not count travels days and half days.

Show your intent. States with a subjective test often require you to completely sever ties with them to avoid 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 residence. Drivers’ licenses, auto registrations, voter registration, and church and club memberships all must be changed. 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, as we saw New York try in the case described earlier.

Major problem points for many people are real estate and businesses. 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, then you never really left. If you want a place to return to in a state, at a minimum you should downsize. Sell the old house and buy a smaller one. Or rent a new place instead of maintaining ownership of property. But even these measures have risk 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 is not a good idea to leave behind valuable items ? such as jewelry, furs, and art. Many states consider that leaving valuable items in the state, 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 there. 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 all these and other documents and pounce on inconsistencies. These actions could trigger fraud penalties in addition to a tax bill.

State 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 think their time is better spent elsewhere by clearly establishing you moved.

RW September 2015.