During the Coronavirus pandemic, many workers, especially those living in cities, have adapted quite well to working from home – sometimes an out-of-state second home. For most, working from home is temporary. For others, as they reflect on their new reality, perhaps not. Over the past few months, we’ve been getting questions from clients asking how to change their state residency to that of a lower taxed state, the state of their second home. Quoting the frequent answer to the question of “status” from online social media: “it’s complicated.”
A few years ago, following the Tax Cuts and Jobs Act of 2017, which eliminated or severely capped the itemized deduction for state and local taxes, I had many client discussions on the requirements for changing one’s residency to a state with lower taxation. Now, as back then, the short answer is the same — one can change their tax nexus to a lower taxation state, but very often doing so not only is complicated, it also can be inconvenient and disruptive to one’s life. This is a decision that entails both a financial analysis and introspective family discussions as to the nonfinancial implications.
You Can Change Your Domicile to Avoid State Taxes — But Is It Really Worth Doing So?
State tax laws are statutorily complex, and rarely are driven by what one may consider as “common sense.” During the process of a state’s taxing authority determining whom they believe is subject to its taxation, the primary consideration centers on the concept of an individual’s “domicile.” Domicile, broadly defined, is one’s place of permanent connection; the place where one always intends to return after an absence. An individual can have only one domicile at a time – establishment of a new domicile means the abandoning of the previous one. The determination of domicile is multi-factored and often requires some interpretation of how well an individual’s facts and circumstances fit the state’s their statuary framework and audit guidelines.
Many individuals believe that since they already have a residence in their state of transition, all that is required to complete the change domicile can be satisfied by obtaining a new driver license and changing their voter registration. These changes alone, especially without the corresponding sale of the residence in the departing state, would leave one with a very minimal chance of prevailing the almost inevitable state tax audit.
My senior tax partner, Donna Cuiffo, recently wrote an article “4 Factors to Consider Before Making Your Second Home Your Domicile” that discusses some of the factors a state tax auditor would consider in determining the legitimacy of the change of domicile. The “facts and circumstances” factors that are considered include: the amount of time spent in each location; the retention of strong business affiliations at the prior location; as well as family connections and lifestyle factors.
For many, when considering the overall merits of changing one’s domicile, the lifestyle and family issues more than offset the related complications, and any tax savings are a secondary bonus. For some, the state income tax savings can be the deciding factor that moves a family to action – especially when relocation already was a consideration. And for the rest, the tax savings alone will not drive the decision.
As states vary as to how aggressively they will challenge and scrutinize changes of domicile, always consult your tax advisor to discuss fact patterns and statuary nuances when considering this change.