If you live in an unfriendly tax state such as New York or California, it’s not uncommon for your retirement plans to include a move to a more tax friendly state once your working years are over. Many southern states offer nicer weather, no income taxes, and lower property taxes. According to data from the US Census Bureau, more residents left New York than any other state in the U.S. Between July 2017 and July 2018, New York lost 180,360 residents and gained only 131,726, resulting in a net loss of 48,560 residents. With 10,000 Baby Boomers turning 65 per day over the next few years, those numbers are expected to escalate as retirees continue to leave the state.
When we meet with clients to build their retirement projections, the one thing anchoring many people to their current state despite higher taxes is family. It’s not uncommon for retirees to have children and grandchildren living close by so they greatly favor the “snow bird” routine. They will often downsize their primary residence in New York and then purchase a condo or small house down in Florida so they can head south when the snow starts to fly.
The inevitable question that comes up during those meetings is “Since I have a house in Florida, how do I become a resident of Florida so I can pay less in taxes?” It’s not as easy as most people think. There are very strict rules that define where your state of domicile is for tax purposes. It’s not uncommon for states to initiate tax audit of residents that leave their state to claim domicile in another state and they split time travelling back and forth between the two states. Be aware, the state on the losing end of that equation will often do whatever it can to recoup that lost tax revenue. It’s one of those guilty until proven innocent type scenarios so taxpayers fleeing to more tax favorable states need to be well aware of the rules.
Residency vs Domicile
First, you have to understand the difference between “residency” and “domicile”. It may sound weird but you can actually be considered a “resident” of more than one state in a single tax year without an actual move taking place but for tax purposes each person only has one state of “domicile”.
Domicile is the most important. Think of domicile as your roots. If you owned 50 houses all around the world, for tax purposes, you have to identify via facts and circumstances which house is your home base. Domicile is important because regardless of where you work or earn income around the world, your state of domicile always has the right to tax all of your income regardless of where it was earned.
While each state recognizes that a taxpayer only has one state of domicile, each state has its own definition of who they considered to be a “resident” for tax purposes. If you are considered a resident of a particular state then that state has the right to tax you on any income that was earned in that state. But they are not allowed to tax income earned or received outside of their state like your state of domicile does.
States Set Their Own Residency Rules
To make the process even more fun, each state has their own criteria that defines who they considered to be a resident of their state. For example, in New York and New Jersey, they consider someone to be a resident if they maintain a home in that state for all or most of the year, and they spend at least half the year within the state (184 days). Other states use a 200 day threshold. If you happen to meet the residency requirement of more than one state in a single year, then two different states could consider you a resident and you would have to file a tax return for each state.
Domicile Is The Most Important
Your state of domicile impacts more that just your taxes. Your state of domicile dictates your asset protection rules, family law, estate laws, property tax breaks, etc. From an income tax standpoint, it’s the most powerful classification because they have right to tax your income no matter where it was earned. For example, your domicile state is New York but you worked for a multinational company and you spent a few months working in Ireland, a few months in New Jersey, and most of the year renting a house and working in Florida. You also have a rental property in Virginia and are co-owners of a business based out of Texas. Even though you did not spend a single day physically in New York during the year, they still have the right to tax all of your income that you earned throughout the year.
What Prevents Double Taxation?
So what prevents double taxation where they tax you in the state where the money is earned and then tax you again in your state of domicile? Fortunately, most states provide you with a credit for taxes paid to other states. For example, if my state of domicile is Colorado which has a 4% state income tax and I earned some wages in New York which has a 7% state income tax rate, when I file my state tax return in Colorado, I will not own any additional state taxes on those wages because Colorado provides me with a credit for the 7% tax that I already paid to New York.
It only hurts when you go the other way. Your state of domicile is New York and you earned wage in Colorado during the year. New York will credit you with the 4% in state tax that you paid to Colorado but you will still owe another 3% to New York State since they have the right to tax all of your income as your state of domicile.
Count The Number Of Days
Most people think that if they own two houses, one in New York and one in Florida, as long as they keep a log showing that they lived in Florida for more than half the year that they are free to claim Florida, the more tax favorable state, as their state of domicile. I have some bad news. It’s not that easy. The key in all of this is to take enough steps to prove that your new house is your home base. While the number of days that you spend living in the new house is a key factor, by itself, it’s usually not enough to win an audit.
That notebook or excel spreadsheet that you used to keep a paper trail of the number of days that you spent at each location, while it may be helpful, the state conducting the audit may just use the extra paper in your notebook to provide you with the long list of information that they are going to need to construct their own timeline. I’m not exaggerating when I say that they will request your credit card statement to see when and where you were spending money, freeway charges, cell phone records with GPS time and date stamps, dentist appointments, and other items that give them a clear picture of where you spent most of your time throughout the year. If you supposedly live in Florida but your dentist, doctors, country club, and newspaper subscriptions are all in New York, it’s going to be very difficult to win that audit. Remember the number of days that you spend in the state is just one factor.
Proving Your State of Domicile
There are a number of action items that you should take if it’s your intent to travel back and forth between two states during the year, and it’s your intent to claim domicile in the more favorable tax state. Here is the list of the action items that you should consider to prove domicile in your state of choice:
- Register to vote and physically vote in that state
- Register your car and/or boat
- Establish gym memberships
- Newspapers and magazine subscriptions
- Update your estate document to comply with the domicile state laws
- Use local doctors and dentists
- File your taxes as a resident
- Have mail forwarded from your “old house” to your “new house”
- Part-time employment in that state
- Join country clubs, social clubs, etc.
- Host family gatherings in your state of domicile
- Change your car insurance
- Attend a house of worship in that state
- Where your pets are located
Dog Saves Owner $400,000 In Taxes
Probably the most famous court case in this area of the law was the Petition of Gregory Blatt. New York was challenging Mr Blatt’s change of domicile from New York to Texas. While he had taken numerous steps to prove domicile in Texas at the end of the day it was his dog that saved him. The State of New York Division of Tax Appeals in February 2017 ruled that “his change in domicile to Dallas was complete once his dog was moved there”. Mans best friends saved him more than $400,000 in income tax that New York was after him for.
When we discuss this topic people frequently ask “what are my chances of getting audited?” While some audits are completely random, from the conversations that we have had with accountants in this subject area, it would seem that the more you make, the higher the chances are of getting audited if you change your state of domicile. I guess that makes sense. If your Mr Blatt and you are paying New York State $100,000 per year in income taxes, they are probably going to miss that money when you leave enough to press you on the issue. But if all you have is a NYS pension, social security, and a few small distributions from an IRA, you might have been paying little to no income tax to New York State as it is, so the state has very little to gain by auditing you.
But one of the biggest “no no’s” is changing your state of domicile on January 1st. Yes, it makes your taxes easier because you file your taxes in your old state of domicile for last year and then you get to start fresh with your new state of domicile in the current year without having to file two state tax returns in a single year. However, it’s a beaming red audit flag. Who actually moves on New Year’s Eve? Not many people, so don’t celebrate your move by inviting a state tax audit from your old state of domicile.
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.