With the recent Tax Cuts and Jobs Act placing a $10,000 cap on state tax deductions, many people are seeking to establish residency in a lower-tax state. According to Accounting Today, while California, New York, New Jersey, Connecticut, and Rhode Island are considered “high-tax states,” Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming are considered “low-tax” because they do not collect personal income tax. Even Donald Trump recently announced that he plans to establish residency in Florida to avoid the high taxes in New York state. Unfortunately, with so many residents of highly taxed states migrating and establishing residency elsewhere, state governments are performing “residency audits” to determine whether taxes can still be collected.
Who is being audited?
These residency audits primarily affect high income individuals and can be very costly for the taxpayer if it is determined that they do in fact owe taxes to their previous high-tax state. New York, for example, wins over half of its audits, and the average amount collected from the roughly 3,000 residency audits initiated on high net-worth individuals is $140,000 per person. If the individual in question still owns property in the high-tax state, it is even more likely that they will be targeted for an audit.
What do these audits look for?
State governments use a variety of methods to test for domicile or statutory residence (which looks for evidence that proves that the taxpayer has spent 183 days or more in the high-tax state in the fiscal year.) For the statutory test, auditors employ high-tech methods such as reading cell phone records, credit card swipe histories, flight records, doctor’s records, and even social media feeds to determine whether the taxpayer has been in-state for 183 days or more. If findings suggest that they have, they are considered a statutory citizen and may be subject to double taxation since they must pay tax in two states.
The domicile test is more subjective than the statutory test and takes into account factors such as which house is larger, where most of the taxpayer’s “prized possessions” (such as photo albums, artwork, and jewelry are kept,) and where family members live and attend school.
Steps to Take When Attempting to Establish Residency in Another State:
If you are thinking of establishing residency in another state, make sure to do the following:
• Consult your tax professional before taking any steps toward establishing residency
• Document your days in both the new and old states of residency. You can also use a day counter app to do this
• Look into the five-factor domicile test and plan accordingly
• If you do get audited, employ representation as quickly as possible to avoid falling into any traps that may be laid out for you in the auditing process.
Establishing residency in another state is a tricky business that can potentially have unintended tax consequences. If you are thinking about starting the process, it is important to talk to your tax professional, be aware of the residency tests employed by state governments, and keep extensive documentation to protect yourself in the event of an audit.