Taxpayers are constantly searching for ways to reduce their income tax liability. One common way is people trying to establish residency in a state with no income tax (Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming) or with limited tax only on certain investment income (New Hampshire and Tennessee). There are many common misconceptions about what it takes to establish residency in one of these states for tax purposes.For tax purposes there are two types of residency:
- Statutory Residency – Typically, once you spend more than 183 days in a specific state, you become a statutory resident of that state.
- Domicile – The permanent legal home that you intend to use for an indefinite or unlimited period and to which, when absent, you intend to return.
By these definitions, it is possible to be a tax resident of more than one state at a time. For example, if Taxpayer A lives with his family in New Jersey but works 5 days a week in New York City, he would be a domiciled resident of NJ, and a statutory resident of New York. Despite living in NJ, because Taxpayer A spends part of his day 5 days a week in NY, he has spent more than 183 days in NY and is considered a NY resident.
Determining a taxpayer’s domicile is not as black and white, thus creating more opportunity for misinterpretation of the laws and the added risk of changing your home tax state. In order for a taxpayer to change their tax home from one state to another, they must be able to prove that they have changed their domicile.
Factors considered in determining domicile include:
- Where you vote
- Location or property you own
- Length of residence
- Business and social ties to the community
One of the most important factors used when states are attempting to determine domicile is the business and social ties to the local community. Because of this, taxpayers must be truly making a change in their life to warrant the change in tax home. No longer is it enough to register to vote and change the registration on your cars to Florida when attempting to claim Florida residency.
When trying to determine a taxpayer’s domicile, states will now often look at the following business and social ties to the community of a taxpayer:
- Church affiliation
- Doctor’s & dentist’s office
- Location of family and close friends
- Children’s school
- Size/value of two homes
- Family/holiday gatherings
- Location of automobiles
- Professional network
- Recreation and social clubs
The most effective way to change tax residency is to make changes around a specific life event such as marriage, retirement, job change, or family change in order to prove to the departing state that a domicile change was not done in bad faith to avoid taxes. A key point to remember is that it is not the duty of the taxpayer to prove why they now live in a new, tax-favorable state. Their duty is to prove to the departing state that they no longer live there by presenting the facts triggering the move and the resulting situation. Most importantly, it is always best to consult a tax advisor well before making a change so they can best advise how to do everything possible to avoid conflict with your departing state.
Written by Stephen Davis, CPA; Tax Manager