Do you have clients who can answer "yes" to any of these questions: Are you considering changing your state residence? Do you have more than one home? Are you thinking of selling your business, retiring and moving from an "historic" home? If so, state income tax implications can be significant.
Generally, an individual is subject to income tax on all of their income (including interest, dividends and capital gains) in his or her resident state. However, a non-resident of a state is typically only subject to income tax on amounts earned within the state, such as compensation or business income sourced to the state--not interest, dividends, or capital gains from investments.
A resident may be defined as a domiciliary of the state that is the fixed and permanent place of residency of the taxpayer. An individual can have only one domicile, and once established, clear and convincing documentation may be required to prove that the taxpayer has changed domicile. A resident for New York tax purposes, for example, may also include an individual who maintains a permanent abode in the state--such as an apartment in New York City--for substantially all of the tax year, and who is physically present in the state for more than 183 days, whether for work or play. Note that any part of a day physically spent in the state is often considered an entire day under this 183-day test.
The New York State Department of Taxation and Finance is notorious for aggressively auditing individuals who have homes in New York and elsewhere. For example, in the widely publicized case involving Yankee baseball great Derek Jeter, the state argued that Jeter had changed his tax domicile from Florida (a "no income tax state") to New York City, an exorbitantly high tax-rate jurisdiction. This matter was recently settled, and both parties had no comment.
Accordingly, individuals who have more than one residence should beware: Which state of residency will subject the individual to tax? The answer is not always clear. Moreover, the tax cost (which typically includes interest and may result in penalties), professional fees, and the time needed to defend audits can be significant. For example, again consider New York's aggressive auditors who, at the least, often require a taxpayer under audit to provide the following:
oDiaries and credit card, bank and utility statements to demonstrate where the taxpayer spent his or her time;
oDocumentation to support active trades or businesses;
oThe location of "items near and dear," such as art, antiques and heirlooms;
oSupport concerning the size and value of homes.
Moreover, the state may send investigators to a taxpayer's New York City apartment, if any, to question doormen or the concierge about the frequency of the individual's presence there. Obviously, such examinations are not only costly, but personally intrusive as well.
If you sell your business, retire and move from an "historic" home, there may be significant state tax implications. For example, Mr. Bigbucks a New York domiciliary, sells his business for a taxable gain of $10 million with a 10-year installment payout, and moves to the no-income-tax state of Florida where he becomes a tax resident. Not only will Mr. Bigbucks pay New York resident income tax on the $1 million he receives in the year of the sale, but he will also be required to "accrue" and pay state income tax on the remaining $9 million of taxable gain in that same year--or post a bond with respect to the tax liability.
In addition, consider state income tax consequences of retirement compensation and benefits when a taxpayer changes state residence. Why? A federal law, Public Law Number 104-95, prohibits state taxation of certain retirement income of an individual who is not a resident or domiciliary of the state at the time the payment is made. Again, consider our Mr. Bigbucks. When he moves to Florida and receives certain retirement income as a Floridian, there will be no state or local income tax imposed. Why? Because he is no longer a New York resident or domiciliary at the time the payment is made, and Florida does not impose an income tax. Accordingly, planning may be critical to maximize Mr. Bigbucks' retirement income and avoid or minimize state and local taxes.
In short, "to be or not to be" a resident for state income tax purposes can be a trap for the unwary. With an understanding of the rules and proper planning, however, the income tax implications can be managed.
David Schmutter, CPA, JD, is partner-in-charge, state and local tax services, at Weiser LLP.