A typical 4-year-old can tell you where she lives. For many adults, it’s not so easy.
A lot of money can change hands based on the answer to that question. State income taxes range from nil to nettlesome, and some cities take a slice, too. Many jurisdictions tilt their property tax systems to favor locals. Residency in the right place can put a child in a public school that rivals elite private academies, or a young adult in a highly selective state university at steeply discounted tuition. It can even qualify a financially comfortable citizen for cash handouts.
But where does a person “live” who has two, or three, or four homes — not uncommon these days — and whose office can be a personal computer that fits in a pocket? Or who retires and keeps the old homestead because it is near the grandchildren, but builds a new life next to a golf course 1,000 miles away? Or who boards a boat or a camper and departs for places unknown?
Many people define “home” as the place that gives them the greatest financial advantage at the moment. But so, also, do many states and localities. What follows can be some of the most personal and intrusive conflicts in public administration.
Gilbert P. Hyatt knows that. In 1970, the California inventor filed for a patent on a single-chip microprocessor. The patent was issued 20 years later. Within a couple of years, Hyatt had collected a reported $40 million in royalties. He also had moved to Nevada, which has no income tax.
California tax authorities doubted his claimed change of residence. Hyatt later alleged that they rummaged through his trash, talked to his neighbors, bad-mouthed him to business contacts, and perhaps worst of all, disclosed the location of the laboratory where Hyatt continued to do research, away from what he feared were the prying eyes of Silicon Valley.
Hyatt sued California in Nevada courts for more than $200 million. California claimed sovereign immunity under its own statute, but the Nevada courts refused to be bound by California’s law. In 2003, the U.S. Supreme Court upheld Nevada’s position, allowing Hyatt’s suit to proceed. The litigation, which has cost California at least $8 million in legal fees, continues today.
In Fort Lauderdale, Broward County Property Appraiser Lori Parrish hired a former organized crime investigator to ferret out property owners who claim a homestead exemption but who may actually live elsewhere. One property owner allegedly decided that aggressive enforcement merits an aggressive response: An employee of the National Institutes of Health in Maryland was charged with threatening to infect Parrish’s office with anthrax. (For more on Florida’s homestead system, turn to Shomari Hearn’s article on Page 2.)
‘Domicile’ Determines Residency
The legal concept of “domicile” lies at the heart of most residency cases. Some jurisdictions have adopted statutes defining domicile, but many others rely on court cases stretching back to the 19th and early 20th centuries, an era in which the issue often was which state’s law to apply to inheritance cases. California’s tax regulations provide a typical definition of domicile as “the place where an individual has his or her true, fixed, permanent home and principal establishment. It is the place to which, whenever absent, he or she has the intention of returning....It is the place where a person has the present intention of making a permanent home, until some unexpected event shall occur to induce him or her to adopt another. It is not a place where a person is living for a mere special or limited purpose.”
States and localities often rely on domicile to determine eligibility for government benefits. The Alaska Permanent Fund, which invests revenues collected by the state from development of its oil reserves, will pay a $1,100 dividend this year to every qualifying resident, including children. To qualify, recipients must have resided in Alaska through all of 2006 (generally meaning that the “resident” cannot have been outside of the state more than 180 days) and must “intend to remain an Alaska resident indefinitely.” This domicile-based distribution system was adopted in the 1980s after the U.S. Supreme Court struck down an earlier scheme that would have apportioned dividends according to the length of time an individual had resided in Alaska.
The University of Michigan extends in-state resident tuition only to individuals who demonstrate a “permanent domicile” in Michigan. Applicants who attended or graduated from a non-Michigan college, or who are under age 24 and have a parent residing outside Michigan, or who attended a non-Michigan high school, are presumed to be nonresidents and must document that their presence in the state is not “temporary or indeterminate” to qualify for in-state rates.
When it comes to collecting taxes, however, governments are not so picky. States that have a personal income tax usually tax their residents on all worldwide income. They are constitutionally permitted to tax nonresidents only on income from sources within the state, which most often consists of wages or self-employment earnings and gains from in-state real property. Therefore, when a state becomes aware of substantial income from out-of-state sources, it has a big incentive to classify the recipient as a resident.
Individuals with domiciles inside a state automatically are considered residents, and thus by default are taxable on their worldwide income. (There may be exceptions in cases where the domiciliary does not maintain a residence within the state, as may be the case when someone has accepted a long-term assignment overseas.) But individuals who clearly are domiciled elsewhere also may be classified as “statutory residents” if they maintain a dwelling within the state and are physically present in the state more than a certain number of days in the year, typically 183.
Audits Delve Into Issues, Lives
A government residency audit usually examines both the domicile and statutory residency issues. These audits are inevitably highly personal and often very intrusive.
Suppose Ms. A is an investment banker who works with a Wall Street office, but she spends half her workdays on the road or working from home. She lives with her spouse in Ridgefield, Conn., and maintains an apartment in Manhattan for occasional use on weekends and during deal closings that keep her in New York City late at night. We will assume she made $2 million from her job in 2006, and that she also had $500,000 of capital gains.
Ms. A will file a resident tax return in Connecticut reporting the entire $2.5 million of income. She will file a nonresident return in New York, reporting the $2.5 million but only classifying $1 million — half the earnings from her job — as taxable in New York. New York’s tax rate is higher than Connecticut’s, so although Connecticut will give Ms. A credit for part of the New York taxes she pays, Ms. A actually bears some out-of-pocket cost for any New York taxes.
Ms. A. is a prime candidate for one of New York’s aggressive residency audits.
First, the auditor will consider whether Ms. A. has a New York domicile. He will inquire whether Ms. A ever had a New York domicile, as might be the case if the Manhattan apartment was her primary residence before the Ridgefield house was purchased. If Ms. A. ever had a New York domicile, the burden is on her to demonstrate, by “clear and convincing” evidence, that at some point in the past she actually abandoned her New York domicile. Her continuing apartment and job contacts with New York make this burden difficult to meet.
The auditor is instructed to consider five primary factors to determine domicile: 1) The usage of the New York home versus the usage of the out-of-state home; 2) active involvement in a New York business; 3) analysis of where the individual spends time during the year; 4) location of items “near and dear” to the taxpayer; and 5) family connections. Viewed collectively, these factors must provide clear and convincing evidence that a former New Yorker intended to change his or her domicile. Someone who never has resided in New York usually will not run into domicile problems unless the combined weight of these factors clearly and convincingly shows the establishment of a New York domicile.
The second factor, in particular, can stack the deck in favor of New York taxation. The owner of a New York business may move out of state and spend 10 months each year outside New York, managing the business remotely during that time. New York views the owner’s continuing involvement in the business as an indication of continued domicile, which makes no sense. The owner’s involvement in a new Florida business, for example, would not be considered an indication of non-New York domicile. Since a nonresident can be involved in a New York business, especially remotely, just as easily as a resident, it is difficult to see how this factor helps demonstrate domicile other than simply to justify the finding that New York would like to make.
Where Do You Spend Your Days?
If domicile does not classify Ms. A as a New York resident, the auditor will try to establish whether Ms. A. is a statutory resident. The Manhattan apartment clearly is a permanent place of abode within New York, so the only issue is whether Ms. A. was physically present in New York more than 183 days in the year. The burden will be on Ms. A. to prove that she was not. The auditor likely will ask for bank and credit card statements, telephone records, appointment calendars and other documentary evidence to support Ms. A’s position that she did not exceed the legal threshold.
Ms. A could easily fall into some common traps. If she drives to Manhattan on a Saturday evening to see a Broadway show and then returns to Ridgefield, that counts as a day in New York. If she and her spouse go to a club after the show and stay past midnight, returning to Ridgefield in the wee hours of Sunday morning, that counts as two days. A couple of hours spent watching a child’s hockey game in Carmel, N.Y., would count as a day. A week at a vacation lodge in the Adirondacks could add seven days to the tally. In fact, virtually the only entries into New York that would not count would be if Ms. A. traveled directly from her home to one of New York’s airports to catch a flight out of state, without stopping along the way, or if she drove through the state without stopping en route to New Jersey, Pennsylvania or points beyond.
Even if Ms. A avoids being classified a statutory resident, she is not necessarily finished with the audit. Suppose Ms. A spent 30 workdays at home, reviewing deal documents and making telephone calls from her study in Ridgefield. In most cases, this would be irrelevant. But New York takes the peculiar position that when a nonresident works at home, such work counts as a day worked in New York for purposes of allocating the nonresident’s wages between New York and other states, unless the work at home is performed for the “convenience of the employer” — a test that, in real life, is seldom met.
Thus, although the 30 days Ms. A worked at home do not count toward making her a statutory resident of New York, they do have the effect of increasing the share of her compensation that New York will tax. To make matters worse, Connecticut only offers a credit for tax on the days Ms. A actually worked in New York, so she will be taxed twice on the earnings allocated to those 30 days. If she worked a total of 200 days in the year, this will result in double taxation on $300,000 of income, because 30 days represents 15 percent of her $2 million in wages.
New York, like most states, seems to retain a home-field advantage in its appeals system as well as in its tax rules. When a Cardozo Law School professor, Edward Zelinsky, challenged the convenience of the employer doctrine in the New York Court of Appeals (the state’s highest court) in 2003, the court upheld the rule 7-0. Two years later, it reached the same result on a 4-3 vote in the case of Thomas Huckaby, a Tennessee resident who did most of his work for a New York employer from his home office in Nashville.
The only further appeal lies to the U.S. Supreme Court, which to date has shown a keen disinterest in the issue. The court declined to hear the Zelinsky and Huckaby cases.
That leaves only Congress to ease the inequities of interstate taxation. Congress acted in one area in 1996, when it ruled that only a current state of residence, not a state where a taxpayer previously worked, can tax certain retirement payments. Legislation to eliminate New York’s convenience of the employer doctrine, introduced by Connecticut’s congressional delegation, died in Congress last year, but is likely to be reconsidered in the current session.
Regardless of whether Congress ultimately passes the legislation, which its sponsors call the Telecommuter Tax Fairness Act, caveat civis. Your home may not be where you think it is.