Where do you live?
For some people, it’s a simple question. For others, it may involve a complicated set of qualifiers and explanations; for an unlucky few, it can result in an extended fight with tax authorities.
The complicating factors that can muddy a person’s answer vary. Many people have more than one home between which they split their time, often in different states. Today, your “office” may be a smartphone, tablet or laptop, carried along with you wherever you go. Perhaps your job has sent you abroad for a temporary but extended period, or you are a member of the armed forces who faces frequent moves.
Splitting your time between two or more locations can be good business or an enriching lifestyle choice. But while home is said to be where the heart is, that definition is unlikely to pass muster with state and local tax authorities, who have a vested interest in a more specific definition.
States that charge personal income tax – most of them – generally tax their residents on worldwide income. In contrast, nonresidents are taxed only on state-source income, such as wages earned in the state or gains on the sale of in-state real property. As such, states have a big incentive to classify taxpayers as residents whenever they can.
This is where the concept of domicile comes in. Individuals domiciled in a state are automatically considered state residents. Barring a few exceptions, this means the state is entitled to tax the individual’s worldwide income. Individuals domiciled elsewhere may still count as “statutory residents” if they maintain a dwelling within the state and are physically present in the state for more than a certain number of days in the year (typically 183).
Given the tax revenue at stake, it is perhaps unsurprising that establishing domicile can be a highly contentious issue, especially for individuals with large amounts of out-of-state income in play. New York state in particular has carved out a reputation for aggressively working to prove that taxpayers are domiciled in New York, even when such claims defy common sense. But New York tax authorities are far from alone. Examples are easy to find not only in New York, but also in Pennsylvania, Georgia and many other places.
To avoid confusion over domicile, especially if you live or work in more than one place, it is important to understand what factors determine it. To do so, you must first understand how domicile differs from residency.
Domicile and residency are different in that a person can have many residences, but only one domicile. Domicile is a taxpayer’s fixed, principal and permanent home. In other words, it constitutes the place to which a person intends to return, even if he or she is currently residing elsewhere.
Tax authorities look at a number of factors when assessing domicile. No one factor is conclusive, and factors often vary from state to state. Given this ambiguity, it is wise for a taxpayer to offer as much evidence as possible when making or defending a domicile claim. Domicile factors may include, in no particular order:
- State of voting registration and actual voting
- Political activity, including candidate contributions at a state or local level or participation in a political group within the state
- State income tax return filings
- Location of real property and residence(s)
- Mailing or forwarding addresses
- Location of valuables and sentimental belongings
- State of car license, driver’s license and automobile registration(s)
- Location of most valuable cars
- State of professional license issuance
- Place of business
- Active involvement in state business
- Family location and connections
- Location of children’s school, if any
- Length of time one has been present in the state and physical presence during the year
- Usage of home within the state compared to usage of out-of-state home(s)
- State of memberships, such as in religious organizations or social clubs
- Location of bank and investment accounts
- Location of professional service providers, such as your doctor, lawyer or accountant
- Location of cemetery plot
Once domicile is established, it is generally presumed to continue until it is abandoned and a new domicile is established. The individual is responsible for demonstrating that his or her domicile has changed, beyond simply moving from one state to another or making a former second home one’s primary residence. This is especially important for taxpayers leaving a high income tax state, such as New York, for a state with low or no income tax, such as Florida, since tax authorities may vigorously dispute such a change in domicile.
There are three main considerations needed to prove a change in domicile: 1) actual presence in the state in which you intend to establish a new domicile; 2) the intention to remain in the new state permanently or indefinitely; and 3) the intention to abandon your old domicile. In essence, the previously discussed factors are all ways to demonstrate one or more of these intentions.
Termination of your old domicile may involve documenting or communicating the change to the appropriate taxing authorities in your former state. Perhaps unsurprisingly, it is often harder to convince your old state to let you go than to establish domicile in a new state, due to tax revenue concerns. Depending on the state you are leaving, the tax authorities may closely scrutinize your move. Many states have recently increased their department of revenue staff levels, largely to monitor attempted changes in domicile. Termination of your old domicile is further complicated by the fact that the precise definition of domicile can vary from state to state. Some jurisdictions define it by statute, while many others base the definition on court cases and precedent. In every instance, the question of domicile will depend on the individual facts of the case under consideration.
The required level of attention makes it wise to work with your financial adviser and legal counsel to fully consider the ramifications of changing your domicile before you begin. Professional assistance may also help you to think through and execute the necessary steps and documentation that support a smooth transition.
All this may raise the question: Why bother changing your domicile when it is such a challenge to prove you have done so? The primary advantage is that not all states are created equally when it comes to taxes. Tax rates vary from state to state, and if you live in multiple locations, one state may have a much lower rate than the other, or even charge no income tax at all. Similarly, some states don’t charge an estate tax, or have more favorable rates. With the exception of real property located elsewhere, establishing domicile in a state without a state inheritance or estate tax can let you avoid such taxes in your estate planning.
Taxes are not, however, the only reason to change your domicile. A variety of benefits may be available to domiciliaries of a state, such as reduced resident tuition rates for state colleges and universities. Most states also give residents a small tax break if their home is a principal residence. Property ownership is governed largely by domicile too. The laws of your state of domicile will determine your rights to retain property and the strength of claims against such property. States with community property laws can complicate matters if one spouse in a couple is domiciled there but the other is not. Finally, the laws of your state of domicile can have a big impact in cases involving marital dissolution or the effectiveness of asset protection strategies.
Though there is no way to perfectly avoid a dispute with tax authorities, knowledge and forethought are your best allies when determining or changing your domicile.