Taxpayers of high-tax states often contemplate relocating and establishing their domicile in a more tax-friendly state. With the latest tax act and the maximum federal deduction available for state and local taxes capped at $10,000, many more taxpayers are posing this question and exploring a strategy to change their domicile. The strategy and success of changing domicile is impacted by several factors and must be evaluated based on each taxpayer’s fact pattern.
Your domicile is important because it affects your liability for state income taxes, your eligibility for certain state benefits (in-state tuition, disability and Medicare benefits) and the jurisdiction where your will is probated.
First, we need to clarify the terminology:
- Domicile: Your domicile is the state where you maintain your legal residence. It is your fixed and permanent place of abode in which you intend to remain indefinitely or to which you intend to return. Domicile is determined by intent, rather than by the length of time you spend in a state. A person may have only one domicile, although one may have more than one home.
- Residence: Your residence is the place you actually live and this fact alone has little legal significance. It is possible to be a resident of more than one state.
- Statutory residence: The place where you live and where you are required to pay state income taxes. In some states, if you are physically present for a certain period of time and maintain a place of abode, you’re liable for income taxes in that state. In this situation, you can be subject to double taxation and dependent on multi-state agreements or credits to be in place to avoid this additional burden.
Proving intent and factors in determining domicile are reviewed on a facts and circumstances basis by the taxing authorities. There is not one factor or a certain combination of factors that are outlined by the courts. Your intent to make a state your domicile can be evidenced by some combination of:
- Physical presence (amount of time spent in the state)
- Residence (taxpayer owns or rents a residence in the state)
- Bank accounts
- Voter registration and actual voting
- Driver’s license
- Car registration
- Business connections and relationships
- Family location
- Ties to the local community (charitable giving, public library, member of a house of worship)
- Social clubs
- Professional and medical services (doctors, lawyers, insurance agents)
Taxpayers also bear the burden of demonstrating abandonment of their former domicile and it is again based on intent. Taxpayers must establish residence in a new jurisdiction, intent to abandon their old domicile and intent to establish domicile in the new jurisdiction.
Changing domicile does not automatically relieve tax burdens for those currently subject to multi-state taxation due to business income or other income sourced to other jurisdictions. For example, a New Jersey resident that owns a business operating there as pass-through entity decides to change his domicile to Pennsylvania. The business income will remain New Jersey-sourced and generate a New Jersey filing requirement at the state’s higher rates. He will receive a credit in Pennsylvania for the taxes paid to New Jersey up to the Pennsylvania tax rate (3.07%), but will still pay the higher tax rate to New Jersey (8.97% maximum).
High tax states are not only unfriendly in the imposition of tax, but tend to aggressively pursue taxpayers they feel may be negatively impacting their tax revenue. The taxpayer bears the burden of proving domicile to taxing authorities. Undergoing a state residency audit is a tedious and expensive process. Taxpayers are asked to furnish bank statements, credit card statements and cell phone records to demonstrate their location on a daily basis via their electronic trail. Change in domicile cases are frequently contested, especially in moves from high-income tax states to low-or-no-income tax jurisdictions.
New Jersey, New York and California are among the states imposing the highest tax rates on their residents. The states with no income tax are Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. New Hampshire and Tennessee do not impose tax on earned income, but do tax investment income.
While New Jersey and California are introducing legislation to re-characterize property taxes as charitable contributions in order to allow these state residents to still benefit at the federal lever from their property tax payments, these bills will likely face significant challenges from the federal government.
Changing domicile is a complex decision and process. Before you start packing, contact me or any of the other professionals in the Individual and Family Office Services Group at Mercadien at firstname.lastname@example.org or 609-689-9700 to help you navigate through a change in domicile decision.