How to Determine State Residency for Tax Purposes
Avoid Double Taxation – Know what It Really Means to “Move” to Another State
For high net worth individuals looking to move to another state to avoid outsized state income taxes, successfully doing so is getting harder each year.
At first glance, the solution is easy: Move to a state that charges no income tax.
But what if you have a business you don’t want to close down? What if you have relatives, friends, or other commitments tying you to your current state? If you keep your residence there, and also buy one in the no-tax state, where do you actually “live”, in terms of taxes?
States have a strong interest in collecting taxes from people still benefitting from their services. So if you are maintaining some sort of residence in more than one state but hoping to pay taxes in only one, you have your work cut out for you.
The stakes are high, especially for high net worth families. Some states tax nearly everything, including work income, business income, real estate income, interest income, investment and dividend growth income, and other kinds of income. If a state determines you ‘live’ there, they will charge you taxes based on all the same sources of income they tax their other residents. For you, that could add up to millions of dollars.
But if another state determines you live there, you could end up paying double taxation on your income – to two different states. Some high net worth families have gone to court over this – and lost.
In other words, if you want to avoid paying taxes in a state you don’t believe is your primary residence, the burden of proof is on you.
Did you truly ‘move’ to the lower tax state?
As you can begin to appreciate, a change of residency is a major decision. Perhaps just as major, is the selection of a wealth manager.
To see if Pillar Wealth Management may be right for you, schedule a chat with CEO and Co-Founder, Hutch Ashoo. When you talk, be sure to mention you’re thinking about a move to another state. Our wealth protection work often includes running several residency scenarios based upon your personal situation.
How States Try to Determine Residency
The first step is to consider the definitions of domicile and statutory residency. These are not the same thing.
The IRS defines ‘domicile’ using two statements:
1. The person intends to use that home (or at least reside in that state) indefinitely.
2. Whenever the person leaves that home, he or she intends to return.
As you can see, that definition leaves a lot of room for disputes. You could “intend” to use a vacation home indefinitely, and whenever you leave it, you do plan to return one day. It might be eight months from now, but you still plan to return.
Statutory residency is a more precise concept, and therefore more complicated. Plus, different states use different rules to determine if you meet their definition of residency.
The seven states with no income tax don’t worry about statutory residency. But for the other 43 states, there are 11 different ways among them that residency is determined. Let’s take a look at two of the biggest states, as examples.
New York Statutory Residency Rules
The first residency test used by New York seeks to determine if you spent more than 183 days – half the year – in the state. And in true modern legalese, “in” is defined to mean setting even one foot in the state, for any part of the day. If you were in the state at all, for any length of time, on a day, that counts as a “day”.
So be careful. If you have a residence in New York, they will require you to prove you were NOT here more than 183 days. That means, you need to keep receipts, travel itineraries, and any other items that prove you were not in the state on days when you weren’t there.
Why? Because New York has stepped up their residency audits on high net worth households, conducting over 3000 in a five year period, and averaging over $140,000 in taxes collected per audit! In total, they generated over $1 billion.
In other words – they’re winning.
Second, New York uses a 5-point domicile test. They look for:
1. Home – which state has the larger home, larger home value and appears to be used the most?
2. Active business – do you have a New York business, even one you’re running from another state?
3. Time – what percentage of time do you spend in each state?
4. Items near and dear – did you move your artwork, wine collection, jewelry, and other valuables to your new state or are they still in New York?
5. Family – where do your children attend school?
Beyond these items, they’ll look at things like church attendance, voter registration, club memberships, and anything else that gives the impression of where you actually live. Still have Yankee season tickets? That’s not going to work out in your favor.
If they determine you live in New York, they’ll tax all your income. If they determine New York is not your primary residence but that you still do business there, you will pay non-resident income tax. This would include real estate rental income and business income if that business is located in New York.
Wealth aside, a change of residency is always a major decision for a family. Just as important for the High and Ultra-high Net Worth Investor is their selection of a wealth manager. Perhaps it may be more important.
To see if Pillar Wealth Management may be right for you, schedule a chat with CEO and Co-Founder, Hutch Ashoo. When you talk, be sure to mention you’re thinking about a change of residency. Because based upon work with other clients, taxes and other expenses can have a significant long term impact on your wealth.
Billionaire Carl Icahn moved his entire company from New York to Florida. He hasn’t explicitly stated that avoiding state taxes on his business motivated the move, but it’s a fairly safe assumption.
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California Statutory Residency Rules
California loves taxes. They will tax your income no matter where you make it if you are a deemed to be a resident of the state. If you open a tuk-tuk business in the mountains of Nepal, but you live in California, you will pay state taxes on your business income. Out-of-state pensions, temporary work, IRAs, real estate in other states – if you make the money, they will tax it.
They also tax out-of-state residents who make income in California. As this article amusingly points out, even Lebron James got taxed by California every time he played there while still a member of the Cavs and his residence was in Ohio.
Like New York, even if you move out of California, if you continue making income in the state, you’ll pay taxes on it.
How does California determine residency?
Come on now – that would be too easy. This is California. According to the same article above from a tax and trust law firm, California’s process is so vague on specifics that you need a tax lawyer to sort it all out. Here are a few items they look for:
• amount of time spent in and out of the state – but no number of days is specified like in NY
• location of your spouse and children
• location of your principal residence
• your state driver’s license and vehicle registration
• if you have professional certifications in the state
• voter registration
• bank locations where your accounts are maintained
• where your doctors, dentists, accountants, and attorneys are located
• social activity locations such as your place of worship, professional associations, memberships
• permanence of your work assignments in California
Again, this is just a partial list.
If you have a vacation home in California, and it really is just a vacation home, you still have to be careful to prevent an audit. For instance, don’t have official government documents mailed to the vacation home.
If you want to see the actual state tax form that tries to explain California’s residence laws, here is the 13-page document.
There are other residency strategies as well. If you’d like, our CEO and Co-Founder, Hutch Ashoo is available to discuss your situation from a wealth protection perspective. When you talk, be sure to mention you’re thinking about a change of residency.
Best State Residency Advice
No matter where you move, if you continue earning income in a state that taxes income, be prepared to pay it. This is one reason many people choose to move to a no-income-tax state. Even if you still have to pay taxes in one state, at least you will be assured of not being taxed twice.
But as you can see, there is no silver bullet to determining your state residency if you have complicating factors such as business, real estate, or important local connections.
Each state has different rules. Some of those rules are clearly spelled out, and some are not. Audits happen, and the person being audited frequently loses, due to inadequate record keeping or decisions they didn’t realize would come back to bite them.
So, if you are jumping into the multi-state residency game, a few tips to remember:
1. Decide where you actually consider your principle residence
2. Move your valuables there
3. Register to vote there and get your car registration and license from that state
4. Get involved in some local organizations
5. Plan to spend the majority of the year there – make your relatives visit you for the holidays, not the other way around
6. Make that your primary mailing address for all your important records
7. Seek professional advice from a tax or legal advisor
8. Seek professional advice from a wealth manager
A fiduciary wealth manager like Pillar Wealth Management can help high net worth households moving to a new state by creating an investment plan that minimizes taxes, incorporates your real estate and business assets, and helps you navigate all these tricky income tax laws so as to maximize your income and allow you to breathe easy.
If you’re considering a new wealth manager as well as a change of residency, we encourage you to reach out to our CEO and Co-Founder, Hutch Ashoo. He can explain the impact of a change of residency on your wealth in your unique situation. When you talk, just be sure to mention you’re thinking about moving to a more tax friendly state.
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