If you’re a financial advisor with clients looking to relocate from a high-tax state to a lower-tax one, know this: The state your client plans on leaving may very well be watching, ready to pounce with a state tax audit to collect some of the tax revenue it will be losing.
New York state, for example, conducts roughly 3,000 non-residency audits annually and has collected approximately $1 billion in revenue between 2010 and 2017 as result of these audits.
The incentive for residents to relocate to lower-tax states and for audits by high-tax states like New York, New Jersey, Connecticut and California has increased after the passage of the massive 2017 tax cut bill, which instituted a $10,000 limit on state and local tax deductions, starting with the 2018 tax returns.
“My clients typically want to become a Florida resident where there’s no estate tax, no income tax and lower property tax rate,” said Eugene Pollingue Jr., a partner in the West Palm Beach, Florida, office of the Saul Ewing Arnstein and Lehr law firm.
They key to avoiding a tax audit when they make the move, says Pollingue, “is complying with the rules of the state they’re leaving from so that state doesn’t still consider that person a resident but one who has moved their domicile … You can’t just buy a condo in Florida and say you’re a Florida resident,” Pollingue said. “You really have to be a Florida resident.”
States have different qualifications for taxpayers to establish their residency.
The most common qualifications are based on time spent in-state within one year, often coupled with owning a home there. New York state, for example, will consider an individual a resident subject to full state income taxes if among other criteria the individual person maintains a permanent place of abode in the state for more than 11 months of the year and spends more than 183 days in the state — just over half a year. New Jersey and Connecticut have similar rules but use one year for their definition of permanent place of abode; Maryland uses six months.
“The concept seems very simple; when you start looking at nitty-gritty it’s not,” Pollingue said.
It’s even more complicated in California, which has the highest state income tax in the country, because the Golden State doesn’t use a set period of time as factor in determining residency. The California Franchise Tax Board instead focuses on the strength of a taxpayer’s ties to the state compared to ties to other states.
The franchise board consider considers factors such as location of spouse and children and principal residence, the state that has issued a taxpayer’s driver’s license and vehicle registration, and the state where the taxpayer votes, maintains bank accounts and has his or her doctors.
“This is a cloudy test … as murky as the San Francisco fog,” said Megan Gorman, managing partner of Chequers Financial Management LLC, who grew up in New Jersey but is now based in San Francisco.
In California and other states such as New York and New Jersey, which also base proof of residency — or non-residency — on facts and circumstances, it’s important that taxpayers document their primary residency because the burden of proof rests with the taxpayer.
“This is not like criminal court where you’re considered innocent until proven guilty,” said Gorman, noting that the this is even more critical in California where tax authorities can look back four years instead of the usual three-year period that the federal government and most states use.
“Remember the tax authorities talk to each other, and if you’re filling out multi-state tax forms and audited by one state, that state will contact the other states and the IRS.” They will also look at social media accounts to check on whereabouts and time frames, said Gorman.
Pollingue noted that states also look at cell phone records.
Both Gorman and Pollingue suggest that taxpayers looking to relocate keep copies or scan of plane tickets, hotel receipts and any other documents that can account for their physical whereabouts as well as a diary or calendar or diary with your location noted for each day.
Gorman noted that the easiest way to prove that a taxpayer has relocated from California is to sever all ties with the state, but that is not necessarily possible.
She and Pollingue stressed that taxpayers consult with a tax attorney or another tax specialist to protect themselves from a state tax audit when relocating.
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