Insights

Thinking of Changing Your State Residency to
Mitigate State Income Taxes? Be Aware of the Potential Pitfalls

The thought of moving to a lower-tax state is more prevalent than ever in light of the federal Tax Cuts and Jobs Act and its restrictive $10,000 cap on state tax deductions. One need look no further than President Trump, who recently announced he plans to establish his residence in Florida, apparently in part to save on New York state and city income taxes.

The seven states that have no personal income tax include Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. Many other states have lower tax rates than the California high rate of over 13 percent or the combined New York State and City highest rate of over 12 percent. Abandoning a state of residence, even a high-tax state, however, is never easy. Further, many want to keep a home in that state because of family, friends and business contacts. If you plan to keep a home in a high-tax state, while intending to change residences to a taxpayer-friendlier state through the ownership or rental of a second home, beware. It’s complicated, and you may end up with a target on your back.

Nonresidents are taxed only on the portion of income sourced to the state such as wage income or rental property income earned in the state. Residents, on the other hand, are taxed on all income, including capital gains, dividend and interest income. For a high-tax state, collecting tax on that second revenue stream can be significant.

Residency audits can be invasive, long, arduous and document-intensive, and the rules are getting more complicated. The burden of proof in a residency audit remains on the taxpayer. The evidence must be “clear and convincing.” A taxpayer must present a compelling case, supported by careful recordkeeping and documentary evidence.

In New York, as in other states, auditors determine residency if either of two tests — domicile or statutory residency (or the 183-day test) — is met.

For the purpose of the 183-day test, New York is now using a whole new set of high-tech tools to track the number of days a taxpayer is present in the state. Auditors now rely heavily on cell phone tracking, which can reveal not only where calls are made and received, but in some cases track data even when you are not using your phone. EZ Pass records, credit card statements, flight occupancy records, swipe cards, doctor’s records and even social media feeds are also used to demonstrate that a taxpayer was present in New York. Further, the tax department can subpoena many of these records.

The domicile test is more subjective than the 183-day test and leaves opportunity for the state to aggressively audit. For this test, auditors primarily look at five factors and, for example, will still want to see that the home in New York is smaller and less expensive than the home in the taxpayer’s new state, and that the taxpayer’s most prized possessions, including their artwork, jewelry, photo albums, family heirlooms and even the treasured teddy bear are in the new state. Further, in addition to looking at where minor children live and attend school, the state, for the domicile test, weighs where other family members, including grandparents and even the family dog, live.

New York wins more than half its audits. Audits can drag on for five years or more. As more high-income individuals leave the state, the number of audits is increasing.

Taxpayers interested in changing their state residency without paying more than their fair share of state personal income taxes should:

  1. See if the 183-day limit may come into play when counting days, save documentation and consider a day counting app;
  2. Understand the five-factor domicile test that New York, Connecticut and other states employ;
  3. Consider a comprehensive analysis of the facts to implement a change in domicile that is as bulletproof as possible;
  4. Seek advice from a state tax expert before taking any significant steps. This can potentially save tens of thousands of dollars.