Moving to a low-tax "paradise" can backfire without the proper planning and documentation, if you don't plan on severing all financial ties from your previous state. Here's how to avoid any tax traps you may not realize are waiting for you.
Many people used to be able to deduct all state and local taxes (SALT) on their federal return. That took some of the sting out of living in a high-tax state. But the new tax law rubs salt into the wound by capping the SALT deduction at $10,000.
Well-off people now have more incentive to move from high-tax states to low-tax ones such as Florida, Nevada, or Washington. But high-tax states—New York, California and others—do not like to let go. They want to keep collecting taxes on people they believe have not truly moved away.
It’s like that Beatles song: You say goodbye, I say hello.Residency and domicile are related but separate tax concepts. Both are important when it comes to state taxes. You may be a resident of more than one state in a given year, but you can be domiciled only in one.
Your domicile is your main home, the place you intend to live permanently and where you return after traveling. You are automatically a resident in the state where you are domiciled.
The burden of proof for establishing a new domicile typically rests with the taxpayer. If you can’t prove it, you can be stuck paying taxes to your old state. New York, for instance, wins more than half of its tax residency audits. Some of these may be individuals trying to cheat the system. But many are likely taxpayers who did not take sufficient care in documenting their lifestyle.
Changing your domicile involves cutting old ties and establishing new ones. If you are moving entirely from state A to state B, a brisk, well-documented moving process is your best chance of avoiding a dispute with state A’s tax authorities.
Save dated moving receipts, copies of your lease or closing documents on a new residence, and any other supporting evidence that will allow you to establish the timeline of your move. Notify your former state’s tax authorities of your move as soon as possible. Renounce any homestead exemption you might have claimed there.
The situation becomes more complex for people who spend substantial amounts of time in multiple states. Creating a paper trail is vital if you retain property in or ties to your old state. Steps may include:
Domicile, though, is inherently subjective. Consider the “teddy bear test.” Where do you keep your sentimental items, such as photographs, collectibles, wedding albums, Mr. Teddy, and your pets (if any)?
But it’s not foolproof. One man kept a variety of valuable and sentimental items in Florida, but his business and family ties remained in New York. New York was also where he received mail, saw doctors and dentists, and kept most of his clothes. As a result, he lost his case when New York challenged his claim that he was domiciled in income-tax-free Florida. Spouses who live in different states may face an uphill battle in establishing separate domiciles, especially if the states have very different tax regimes.
Auditors have also taken advantage of technology in recent years when attempting to determine residency. They now may track cellphone records, review social media feeds, and even look at veterinary records, according to a recent CNBC report. Some New York auditors reportedly have conducted in-home inspections that included checking out fridge contents. Remember, nobody is obligated to allow an auditor in the door or even to talk directly to an auditor.
Tech may be able to help keep your estates straight. The Wall Street Journal recently reported on apps that automatically track the owner’s location and can issue alerts if users are approaching a state’s threshold for residency. These apps aren’t foolproof, however. You shouldn’t rely on them exclusively.
Auditors know that taxpayers could load the app on a phone and then leave that phone in the state where they want to claim domicile and take a second phone when they travel to their original state. So, while these apps can be helpful, the real problem for most taxpayers is not simply how to count days in a given location (though you should do so in whatever way works for you). Tracking your location is only one piece of a larger puzzle.
While there is no surefire way to convince the tax authorities that you have left a high-tax state behind, aside from cutting all ties with the previous state, creating a big-picture case with lots of concrete evidence will work in your favor. The more work and effort you put into demonstrating that you really have moved your domicile, the better your odds that it will be an open-and-shut case when the tax authorities come calling.
Paul Jacobs, Certified Financial Planner (CFP®), IRS Enrolled Agent (EA), is the chief investment officer of Palisades Hudson Financial Group, based in its Atlanta office. He is a contributor to the firm’s newly revised book on financial and life planning, “Looking Ahead: Life, Family, Wealth and Business After 55.”
Palisades Hudson is a fee-only financial planning firm and investment manager based in Fort Lauderdale, Florida with $1.4 billion under management. It offers financial planning, wealth management, and tax services. Its Entertainment and Sports Team serves entertainers and professional athletes. Branch offices are in Stamford, Connecticut; Atlanta, Georgia; Portland, Oregon; and Austin, Texas. The firm’s daily blog and monthly newsletter covering financial planning, taxes and investing are online at www.palisadeshudson.com.