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State estate tax: Dealing with the domicile issues

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When the comedian Joan Rivers died back in September, there was an unusual provision in her estate plan: Rivers’ will named her state of residency as New York, but her domicile as California.

This was clearly done to take advantage of the tax situation in each state: New York has a state estate tax, whereas California does not. But Rivers’ will was filed through the legal system of New York, her primary residence, though probate is usually done in the state of domicile.

Many wealthy older clients face the same decision, since they may have summer and winter residences, or vacation homes in which they spend a significant amount of their time. A person can have many residences, but only one domicile. And that choice of domicile can significantly impact their estate planning. A client should take that decision seriously.

Domicile is typically a question of fact based on the individual’s intent to remain in, or return to, a particular state and permanent place of abode. The California Court of Appeal has provided a good working definition: “domicile” is the one location with which, for legal purposes, a person is considered to have the most settled and permanent connection. 

This definition can be open to interpretation. Some factors that indicate where clients are domiciled include:

  • Where they vote

  • In which state their car is registered

  • The address listed on their tax returns and insurance records; and

  • The state listed on their passport

Estate planning documents can also state a clear intention of domicile. But if these other questions aren’t answered consistently with those documents, there could be some issues around what someone’s domicile actually was, with potential legal proceedings.

So clients who are considering establishing a domicile different from their current one should be prepared to do the job thoroughly and well in advance. The task can be time-consuming. But in some cases, it can be well worth their while.

Here are some benefits enabled by establishing a domicile in the friendliest jurisdiction:

  • State estate tax. Fewer than 20 states currently have their own estate tax, and the exemption levels tend to run far below the federal exemption of $5.34 million per estate. A client can be doing everything right to avoid the federal estate tax. But his or her heirs could get stuck with a sizable estate tax bill if, after the client retires to Rhode Island, that state decides he or she was domiciled there.

  • State income tax. The general rule is that people domiciled in a state pays state tax on all of their income, while those who aren’t domiciled there pay tax only on income derived from sources in the state. This can be less of an issue for retirees, whose income derives primarily from investments and retirement plans.

  • Creditor protection. Bankruptcy protection laws vary from state to state. Most famously, Florida’s bankruptcy laws allow a person to protect their principal place of residency from creditors, even if they file Chapter 11. Clients who fear the possibility of bankruptcy in their future would do well to investigate the bankruptcy laws in their possible states of domicile.

  • Probate. If surviving family members need to start a probate court proceeding, it must begin in the state where the client was domiciled at the time of his or her death.

  • Divorce. Although divorce laws vary widely from state to state, domicile isn’t particularly important here. A client must only meet the state’s residency requirement to file for divorce there.

Two other things to keep in mind regarding domicile rules:

  • It is possible, although unusual, for two (or more) states to claim a person is domiciled there for state tax purposes.

  • Courts have held that a husband and wife can have different legal domiciles if they live separately in a “nontraditional” marriage.

As for Joan Rivers, reports are that her estate was worth $150 million, so estate planning and domicile issues will make a huge difference for her primary heir, her daughter Melissa. But even clients with much less than that can be strategic about their domicile. And it’s never too early to start making those arrangements.