Protecting family wealth and managing the impact of taxes have long been priorities for families, regardless of net worth. Since the Tax Cuts and Jobs Act of 2017 (TCJA), and largely due to the effective repeal of the state and local tax (SALT) deduction, residents of high-tax states have become increasingly aware of the potential tax savings that can be achieved by relocating to a low- or no-tax state.1
The general rule is that a state may tax the worldwide income of a person "domiciled" in that state. Non-residents are required only to pay state income tax with respect to income actually derived from that particular state.
State income tax and local property taxes are not recent creations. However, the TCJA overhauled the federal tax system and specifically disadvantaged residents of states with high income and property taxes. Specifically, the TCJA limits an individual's state and local tax (SALT) deduction to $10,000 for state and local taxes paid. The fallout from the TCJA has been increasing federal tax bills for those with state and local taxes beyond the $10,000 cap. As a result, there have been an increasing number of relocations to non-tax jurisdictions by individuals hoping to reduce their total tax liability. For example, Florida, which has no personal income tax, saw a 3% increase in the migration of net personal income between 2017 and 2018.2
New York, New Jersey, Connecticut, California, Illinois and Hawaii, among others, impose high taxes on residents and decedents.3 Some states, like Florida, Texas, Washington and Nevada impose no income or estate tax.
Property taxes are assessed by local taxing authorities. Cities in states with high state income taxes often have high property taxes. However, some states with no income or estate taxes have relatively high property taxes, like Texas.4 California residents in particular should be cognizant of how their target destination imposes property taxes. Despite its reputation, California has a low property tax rate combined with rules that tie the assessed value to the purchase price of the home. As a result, some California residents, particularly long-time homeowners, may face a steep property tax increase if they relocate.5
The act of physically moving is the easy part. The more challenging aspect is proving with clear and convincing evidence that the prior domicile was terminated and that the new domicile has been effectively established.
There are a number of issues that must be considered in order to effectively change a taxpayer's domicile. Many factors make sense, such as the relative sizes of each residence and time actually spent in each state. Other factors, such as where your pets live, may seem trivial but are derived from statutes and case law.
It is important to understand that each situation requires a separate analysis as to whether a change of domicile has occurred and to what extent a change will ultimately reduce taxes. This article is not intended to be a substitute for tax or legal advice from an experienced attorney.
Domicile and Statutory Residence
An individual's domicile is the state in which they actually reside and intend to remain. Residence in a state without the intention to live there permanently does not suffice. Domicile is subjective by definition and therefore somewhat unpredictable. New York regulations, for example, provide additional guidance, defining domicile as "the place which an individual intends to be the permanent home — the place to which such individual intends to return whenever… absent." The subjective nature of determining one's domicile makes any determination of domicile a fact-intensive inquiry.
What is a Statutory Resident?
Even if an individual successfully changes domicile, spending more than 183 days during the calendar year and maintaining a home in a particular state will typically classify him or her as a "statutory resident" under state law and subject to state tax on all of their income, regardless of its source. A "day" in this context means any part of a calendar day, except when presence in the state is solely to board a plane, ship, train or bus for a destination outside of such state, to receive certain medical care, or if the individual is in active military service.
The Burden of Proving Domicile
If audited by state tax examiners, an individual asserting a change of domicile must prove by clear and convincing evidence that not only did they permanently move to a new state, but that sufficient ties were cut such that the previous domicile was abandoned. Since proving domicile is done on a case-by-case basis, no single factor is controlling and the unique facts and circumstances of each situation will be closely considered. In a case where a New Yorker argued a change of domicile to Florida, the fact that persuasive arguments were made in support of both Florida and New York as the taxpayer's domicile led a court to hold that he had not changed domicile.6 Accordingly, establishing strong ties in a new location may not be sufficient as clear and convincing evidence of intent if strong ties are continued with the previous state.
Steps to Change Domicile
Once established, an individual's domicile continues until he or she moves to a new location with the intention of making a fixed and permanent home there. If an individual decides to change domicile, certain actions should be taken to bolster the evidence of the requisite intent. This will be required both to establish Florida or Nevada, for example, as the new domicile, as well as to terminate the previous state of domicile. Court cases deciding the issue of domicile provide that certain declarations may evidence a change of domicile, but that those declarations are less persuasive than formal and informal acts that demonstrate an individual's general habits of life.
After changing domicile, the departed state may challenge the individual's non-resident filing status for income tax purposes via an income tax/residency audit. During a residency audit, there will generally be an initial determination of "primary factors" followed by a series of "other factors." An examination of primary factors may focus on the following:
- The home. When multiple residences are maintained, a comparison of the size and value of the homes may be significant, as will the use of each residence. While not always the case, ideally the new state's residence will be a larger, permanent home, whereas the previous residence will be a smaller vacation home.
- Business activities. Though it is not required to give up business interests in the prior state, it may be beneficial to devote less time to business carried out in that state and make it more of a passive investment.
- Time spent in former jurisdiction. While spending 183 or fewer days will prevent classification as a statutory resident, the amount of time actually spent in the new state is also quite important. For example, if an individual spends five months in New Jersey, but only three months in Florida, and the remaining four months traveling, it could be argued that status as a New Jersey domiciliary was never abandoned and that the use of the Florida home is merely for vacation.
- Items near and dear. The taxpayer should be able to demonstrate that they have moved sentimental items, such as family heirlooms, works of art, valuable books, stamps and coins, family photo albums and even pets.
- Family connections. This is a limited factor and often includes only a spouse and minor children. A situation in which spouses maintain separate domiciles may create doubt in the view of an auditor.
Aside from the primary factors, there are a number of secondary factors also relevant in determining domicile. These factors are subordinate to the primary factors and are to be considered only if, after weighing the primary factors, it is still unclear whether domicile has been changed. At times, auditors will make their determination based only on the primary factors and never even look into the secondary factors. Nevertheless, since many who are audited maintain a second home or have some sort of business involvement in their former state, it is important that secondary factors are satisfied.
To evidence the intent necessary to change domicile, where possible, an individual should consider taking the following steps:
- File a "Declaration of Domicile" in the county of residence
- Update the address at which bank statements and other correspondence are received
- Relocate any safe deposit boxes
- Obtain new auto, boat and airplane licenses and registrations
- Register to vote and vote as soon as eligible
- If applicable, apply for a homestead exemption afforded only to residents of that state
- Join and participate in social, religious and other local clubs or organizations
- Sign a new will and other estate planning documents to ensure such documents comply with and are governed by appropriate state law. The will should declare that the individual is a resident of the desired state.
- File federal income tax returns using the individual's new address, and file a final individual non-resident income tax return in the prior state using the new address on the return
As stated above, it is a misconception that it is easy to change domicile from one state to another. Taking affirmative steps to move one's property and connections out of one's old home is critical to avoiding undesired consequences, such as dual domicile treatment or taxation by another state. Additionally, after changing domicile, individuals should continue to consult with their advisors to ensure they do not run afoul of the statutory resident rule. Taking these steps, individuals can help prevent a potentially painful and expensive audit process and, if an audit does occur, can be well-positioned to show that they have actually changed domicile.