The global pandemic has taught us that work doesn’t have to be done in an office. When the emergency orders were issued in March and April of 2020, confining most of us to our homes, remote work became the norm rather than the exception. As things progressed, people escaped the cities and urban areas and began working remotely. In today’s world, it has become commonplace to relocate on either a temporary or permanent basis.
Whether it is escaping a global pandemic, for a sought-after change, such as a dream job in another state, a post-retirement move to a warmer climate, or for reasons less opportune — military service, serious illness or divorce — don’t let an unintended impact of relocation be an unanticipated state tax bill. Multiple states will claim to be your state of residence and attempt to tax your income.
Increasingly, states are challenging former residents who attempt to change their domicile to another state. Residency audits are on the rise, particularly in states where larger numbers of residents are more likely to spend winters elsewhere.
Although the rules vary among states, generally speaking, most states define a “resident" as an individual who is in the state for other than a temporary or transitory purpose. States consider a person’s “domicile" to be the place of his or her permanent home to which he or she intends to return to whenever absent from the state for a period of time. Most claim the right to tax an individual’s income if they are believed to be a resident and domiciled in that state. Typically, states also impose tax on 100% of a resident’s income from all sources, including portfolio income. Many states have exceptions for military personnel in active service and for individuals receiving medical treatment for an extended period.
During the pandemic, some states issued guidance that relaxed enforcement of their residency rules while executive orders were in effect. As the executive orders expired, the guidance on relaxed enforcement of the residency rules also expired. If employees continued to work remotely and relocated to other states, this could cause dual residency issues for them.
Individuals who may be caught in the trap of dual residency and dual taxation include:
Often, a major determinant of an individual’s status as a resident for income tax purposes is whether he or she is domiciled or maintains an abode in the state and are “present" in the state for 183 days or more (half of the tax year). California, Massachusetts, New Jersey and New York are particularly aggressive in this respect. There and elsewhere, taxpayers have the burden of proving through documentary evidence which states they spend time in during the year and how long they remain in these states.
Other evidence often considered in evaluating whether there has been a permanent change in domicile includes:
In residency audits, state auditors will review:
If you live elsewhere but travel on a regular and frequent basis to another state, it is a good idea to maintain a diary or location log that clearly indicates the dates on which you are in a specific state, accompanied by supporting records such as transportation tickets and receipts. Remember that any part of the day spent in a state, other than when traveling through the state, is generally considered a day spent in the state for residency determination purposes.
Note that the allowable level of participation in charities and social organizations varies among states. Some states, like Wisconsin, do not count such participation against taxpayers claiming nonresident status.
Changing one’s residence takes planning and is a proactive process. While courts consider taxpayer intent in state residency disputes, they ultimately look to documents and facts to decide where the state of domicile is. Careful documentation is key:
If you have previously filed a tax return in your current state but are changing your residence, it is imperative that you closely observe the formalities of making a change of residence and that you retain all documentation you may need to prove your new residency. State tax law generally holds that you are not deemed to have created a new domicile until you have abandoned your former state of residence. In addition, be sure to keep that documentation until your former state’s statute of limitations permitting them to audit a return runs its course.
Changing domiciles while continuing to be actively involved with a closely held company is especially complicated. It can be done, but only with proper planning. However, a portion of the compensation earned or profits from a "pass-through" entity (e.g., S corporation) will remain taxable by the state or states in which business is conducted or services are rendered by the owner to his or her company.
There are many documented cases of states successfully asserting tax claims on former residents’ income. In some instances, this has occurred many years after the individuals moved to another state or took a job overseas and returned to the United States. When changing your residence, be sure you consult with a tax professional so that you understand the benefits (such as lower tax rates) as well as the potential pitfalls. Don’t pay state tax on more than 100% of your income.
For more information on this topic, or to learn how Baker Tilly specialists can help, contact us.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.