Changing State Residency
Changing state residency is something we see regularly due to job changes or retirement, or for income tax reasons. A surprising effect of COVID-19 is the desire for more people to change their residency and the possibility of state income tax problems.
As more people have been working from home successfully, we’ve seen an increase in individuals who are contemplating a move and working remotely from a home in a new state. Also, over the past six months, we’ve seen many employees work from locations other than their primary states of residence because of travel limitations. This article explores the rules regarding moving from state to state and working temporarily from secondary states.
Knowing an individual’s state of residency is crucial. Any state in which the individual may reside has the right to tax that individual on all income earned. If residency is triggered in multiple states at once, total income may be subject to double taxation.
Domicile vs. residence
The terms “domicile” and “residence” are often used interchangeably, but from a tax perspective, they aren’t the same. In a state that imposes a personal income tax on the income of its residents, an individual is considered to be a “resident” if the individual is “domiciled” in the state or if the individual meets the conditions of a statutory residency test.
Generally, an individual is domiciled in a state if the individual intends the state to be his or her permanent home. Such intent is evidenced by such factors as (1) primary residence, (2) the state of an individual’s driver’s license, (3) the state in which an individual has registered to vote, (4) the individual’s employment in the state, and (5) the individual’s family and social connections in the state. Such facts and circumstances apply to a domicile state like Illinois.
In many states, an individual is a statutory resident if the individual maintains a permanent place of abode in the state and spends more than 183 days in the aggregate during the year in the state.
Although state rules vary in what constitutes a permanent place of abode, a state generally regards a dwelling place that an individual continually maintains – whether the individual owns it or not – a permanent place of abode. An individual’s second home or vacation home could meet the definition of a permanent place of abode.
As for the “more than 183 days” rule of the statutory resident test that many states follow, states generally treat an individual’s presence for any portion of a day as a full day for purposes of the day count. It’s recommended that individuals who maintain a permanent place of abode in a nondomiciliary state maintain a calendar to track their days of presence in the state.
Some states don’t apply the “more than 183 days” test in determining whether an individual who’s domiciled in another state should be taxed as a resident. California, for example, treats an individual as a resident for personal income tax purposes if the individual is physically present in California for a purpose other than “a temporary or transitory purpose.”
An individual who’s treated as a resident in both the individual’s state of domicile and state of statutory residency will be subject to tax on all sources of income that such states subject to a personal income tax. While states generally provide a credit for taxes paid to other jurisdictions, the allowance of such credit in dual resident situations may be limited.
Individuals who work from a second home or vacation home in a state other than their state of domicile could be exposed to double taxation on their income if the requirements for statutory residency are met. It’s recommended that individuals who’ve been working from a state other than their state of domicile seek tax advice to prevent any adverse state tax implications.
Steps to change in domicile
A state’s determination of a person’s domicile is a question of fact; no single fact or detail can prove intent. Intent is proved through a cumulative review of an individual’s actions over time. Taking the following steps in the state in which one hopes to make a new domicile can be very helpful:
- Selling a home in the old domicile state
- Business activity in the new state
- Filing taxes as a resident
- Filing a “Declaration of Domicile” if the state has such a procedure (e.g., Florida)
- Registering to vote and voting
- Getting a new driver’s license and passport
- Registering an automobile
- Applying for a homestead exemption in the new state and rescinding it in the old state
- Changing the mailing address and forwarding mail to the new domicile
- Updating estate plan documents (trusts, wills, etc.)
- Update bank account and credit card information
- Rent a safe deposit box in a bank in the new state
- Using doctors, dentists, lawyers and accountants
- Switching gym and club memberships
- Joining a new house of worship
- Making charitable donations to local organizations
- Consider updating funeral arrangements to the new state
- Notifying family and friends of the move
Traps and possible pitfalls
- Avoid the Jan. 1 trap when changing a state domicile. It makes things easy for income tax purposes (no partial-year resident return and nonresident return). It may raise a red flag with state auditors, however, since virtually nobody moves on Jan. 1.
- Income sourcing is often based on the type of income. For example, supplemental income (bonus, options, restricted stock units, etc.) is sourced based on prior year(s) of service. With that in mind, despite establishing a new domicile, an individual may still have income tax trailing obligations to his or her old domicile state.
- If you’re a beneficiary, grantor or trustee of a trust, changing residency may affect the state taxation of the trust. State definitions of a resident trust vary widely and can present some traps. Some state definitions are based on the trustee’s location, while others on that of the grantor or of the beneficiary. This lack of uniformity in definitions of residency could lead a trust to be double taxed.
Given the complex nature of changing residency or potentially having dual residency, proper planning is critical. Please contact your JMG advisor for more information.