How Residency in Two States Can Affect Your Taxes
Can you have residency in two states? And if so, is it a smart move from a financial and tax perspective?
The answers to these and related questions depend a lot on the two states where you want to claim residency.
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Here’s the biggest issue:
As a wealthy investor with high net worth or ultra high net worth, and possibly multiple properties in numerous states, the fallout you’ll suffer for getting this wrong can be very costly.
The last thing you want is to pay a bunch of taxes you could have easily and legally avoided. This article will show you how dual state residency works, answer the most commonly asked questions, and walk you through the pros and cons of living in a no-income tax state.
You have likely spent a lot of time learning about tax avoidance strategies, and one of them is moving to a no income tax state. However, the process can be complicated, which is why you should work with an expert to help you iron out the fine details. Our exclusive Ultimate Guide can help you hire the best advisor for the job!
At Pillar Wealth Management, we only work with clients who have a liquid net worth of 5 million to 500 million in investable assets. This gives us the relevant experience in guiding wealthy investors on an array of wealth management aspects, including the nuts and bolts of dual state residency. If you would like to enlist our services, you can call us to schedule your first consultation.
What is Dual State Residency?
Your place of legal residency, which is usually your permanent home, is known as your ‘domicile.’ When it comes to dual residency, a resident can be defined as a person who is in a particular state for reasons that are not temporary or transitory.
If that sounds kind of vague, it is. And you can blame the states.
Each state can have its own definition of who constitutes a resident that can be taxed.
[Click to tweet: Each state gets to decide who qualifies as a resident that can be taxed]
A dual residency is attained when you are a resident of two states – according to each state’s separate definitions.
Do you see the potential problem?
Depending on where you are classified as a resident, you can get caught up in the trap of dual taxation. Most states can impose taxes on 100% of a resident’s income regardless of where or how it was earned, including their portfolio income.
If you live in two states, where do you pay taxes? You could truthfully live in two states at different times of the year, and both states could in theory charge you taxes on 100% of your total income.
That’s dual taxation. And you must avoid it at all costs.
How is a Change in Residency Established?
How do you establish residency in two states? And how do you dissolve residency in a higher tax state even if you still must spend time there?
Certain factors are used to establish your residency status for income tax purposes.
These are the nuts and bolts of residency:
- Where you are employed
- Whether your employment is permanent or temporary
- Where your business relationships or transactions are located
- The property where you reside, or whether you have rented it out or sold it
- How much time you spend in the state
- Which state you are registered to vote in
- In which state your driver’s license or permits were issued
- Memberships in clubs or organizations
Changing your residency is a proactive process that requires planning and careful documentation.
The more items on that list you can establish in the lower tax state between the two where you want to have dual residency, the better case you’ll have when the tax sharks come.
If you want to know more about what you need to obtain residency in another state, you can consult with a professional expert. Our wealth managers can help you determine where you stand in terms of your tax management and financial management. To get in touch with our team, you can schedule a free consultation.
What is the 183-day rule for state residency?
The 183-day rule is used to determine whether a person can be considered a resident of a country or state for tax purposes.
In the U.S., the Internal Revenue Service (IRS) has a complicated formula to determine residency, which considers the two previous years in addition to the current year when applying the 183-day rule.
In other words:
Establishing dual state residency is tricky, especially when an existing job is keeping you in one state.
When it comes to state residency, you are considered a dual resident even if you live in one state (your domicile state) but commute to another state for work. A common example would be someone who lives in New Jersey but works in New York.
In such cases, you spend more than a majority of the year – more than 183 days – in the other state. This makes you liable for dual taxation on your income.
Can you live in one state and claim residency in another?
As you are starting to realize, this all depends on where your domicile is, and how much time you spend there, as well as each state’s particular rules and definitions.
In other words:
What do you mean by ‘live’ and ‘residency’? Your domicile is where you ‘live’ in the eyes of the government, so it would be pretty hard to claim residency in a different state but not in that one. But again – the details matter, and each situation is different.
Can You Have Residency in Two States and Avoid Income Tax?
So, what can we do about dual taxation? As a wealthy investor, you want to protect your assets, not lose a large amount to taxes every year.
Here’s the most popular way to do it:
Move to a no income tax state.
By moving to a no income tax state, such as Alaska, Tennessee, Florida, Texas, or Washington, you can avoid the dent that taxes can leave on your income. However, as a high-earner, you might need to work or travel to other states frequently.
In many states, you can file a nonresident return in the state where your business is, exempting you from being taxed in that state.
But here’s the kicker:
Not every state allows that. Especially the ones that salivate over tax revenue from anywhere they can get it.
This is one reason why all this depends so much on which states you live and work in. The laws and restrictions are unique to each state.
Working with a professional who is knowledgeable about state taxes can help you figure out if and how a dual residency is the right move for you.
The Advantages of Having Residency in States with No Income Tax
The states with no income tax have certain advantages over other states.
Here are the main points in favor:
You Can Purchase Commercial Real Estate
Here’s a secret:
Commercial real estate, such as office spaces or buildings, has a much lower rate in no income tax states compared to states with high taxes. This is partly due to the lower costs of living in these states.
What might this mean for you?
High net worth and ultra-high net worth investors often have multiple businesses, which makes it beneficial for them to invest in cheaper commercial properties. With the added benefit of lowered expenses, this opens up more opportunities for you to save your wealth and use it for different avenues.
You Can Retain More of Your Wealth
The harsh reality:
High tax states usually charge higher taxes based on wealth. Moreover, these taxes are focused on the income you generate from your investments.
For many rich investors, this is a major income source, making it difficult for them to achieve their goals to enhance their wealth. High tax rates affect your financial status and standard of living since they can bring down your portfolio performance.
Moving to a no income tax state lets you keep more of your earnings and investment growth.
They Have Better Economies
The states that charge no income taxes tend to have better economies, job markets, and economic opportunities than the states which charge high taxes – especially when you factor in the losses you’ll face to the higher taxes.
This allows entrepreneurs and business owners to reap the benefits, and the profits, from a better economic environment.
To make the best of these opportunities, you can implement strategies that help you maximize your returns. Our guide, 5 Critical Shifts for Maximizing Portfolio Growth Strategies – For Families Worth $5 Million To $500 Million, can tell you how.
They Are Ideal for Retirement
When you retire, your active source of income is no longer there to generate money. You rely solely on your passive income sources and your savings.
If a high tax state claims a large chunk of the money every year, you might find yourself in trouble.
Retirement planning helps you prepare for these challenges to a great extent, relying on investment strategies and portfolio management to carry you through challenging times. To avoid excessive taxes, many financial advisors and financial planners advise their clients to consider relocating to states with no income tax.
Capped Tax Deductions
No income tax states cap their tax deductions at 10,000 dollars on state and local deductions from your federal tax returns, even on property taxes.
What does this mean for you?
It means you can receive your income at the state level without worrying about it being affected by tax deduction caps. On the other hand, the highest taxes states would leave high net worth and ultra-high net worth individuals very little room to save anything from their federal taxes.
The Disadvantages of Having Residency in States with No Income Tax
With so many advantages, you might wonder why more people don’t move to states with no income tax. The truth is, the process can be long and tedious, and many people choose not to due to personal circumstances.
There’s also just personal preferences. Alaska? It’s cold. Florida? It’s hot and humid. There are other factors that matter a lot depending on the person.
If you want more clarity on which move is right for you, we suggest that you work with a financial professional. As an investor with over 10 million dollars, you can learn how to find one of these experts through our exclusive Ultimate Guide.
The Process is Complicated
Let’s get real:
Moving to another state is not easy, especially for wealthy individuals. If you work in a high tax state, shifting your business and residence to a state with no income tax can take a lot of time.
Your residency status case might also land you in court for months, and you might end up having more property taxes or income taxes imposed on you.
Moreover, if you move to another state with no income tax but choose to continue working in a high tax state, your income will still be taxed at high rates.
They Can Impose Other Taxes
Just because a state is not charging you with income tax, it doesn’t mean you can enjoy living there without paying any taxes. They still need to maintain a revenue stream to fund their projects.
One way or another:
Every state will find a way to tax you.
Some states might charge you higher property taxes or sales taxes to meet that requirement. Therefore, you might find yourself not saving as much as you’d hoped. A tax attorney can help you better understand the tax laws in your particular state of interest.
Seek Advice from a Professional
If you are concerned about the amount of money you lose to taxes every year in your high-tax state, it is reasonable to wonder, “What is the fastest way to establish residency in a no income tax state?”
The process of establishing dual state residency can be time-consuming and complicated if you tackle it on your own, and with millions of dollars at stake, you don’t want to make hasty decisions. That is why we recommend that you reach out to a professional in the field.
Our team at Pillar Wealth Management can assist you with any financial questions you have, including “Can you have residency in two states?”
Our wealth managers have extensive experience in helping wealthy clients with 5 million to 500 million in liquid assets manage their wealth. We can advise you on tax mitigation strategies to help you preserve your wealth. If you’re interested in learning more, feel free to set up a meeting with someone from our team of experts.
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