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Understanding Residency and Domicile in Determining State Income Taxation
Tuesday, April 16, 2024

State income taxes play a prominent role in overall tax planning for individuals. A change of residence/domicile from a higher-tax state to a lower- (or no-) tax state is often considered when contemplating retirement or the receipt of significant proceeds from a business or investment transaction, or when a taxpayer realizes the amount of state income tax paid upon filing his or her return. Nine states currently have no income tax—Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming—and the rate of state income taxation varies considerably among the states.[*] A change of residence/domicile can be a practical way to decrease state personal income tax liability and preserve wealth.

Residency/domicile is a critical issue in determining state taxation. The general rule is that a state may tax the worldwide income of a person domiciled in that state. Nonresidents of a state generally only pay income tax with respect to income actually sourced from that particular state. In addition, an individual who meets the statutory test of residency in a state, typically based on presence in the state for a designated number of days, commonly 183 days, may be classified as a statutory resident and subject to tax on all of his or her income, regardless of its source. A “day” in this context typically 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 the state. States may provide for other exceptions to this “day” rule, including presence in the state for medical care, presence for purposes of military service, and the like.

While every state has its own approach to taxation, it is important to first recognize the difference between domicile and residency. States vary in their definitions of these terms, but generally agree that domicile is a subjective analysis based on a person’s permanent residence (i.e., the place where an individual has his or her true, fixed, and permanent home without any present intention of leaving, and to which the individual intends to return when absent). An individual can only have one domicile at any given time. Residency can be the same as a person’s domicile, but it also can be a person’s temporary residence (i.e., a second home). A person can have more than one residency in a single tax year.

Changing domicile requires two steps: establishing domicile in a new state and abandoning domicile in the old state. A person asserting a change of domicile must prove by clear and convincing evidence that not only did he or she permanently move to a new state, but that sufficient ties were cut with the prior state such that the previous domicile was abandoned. A determination of domicile is generally based on consideration of all of the facts and circumstances. To evidence a change of domicile, certain actions should be taken to bolster the evidence of the requisite intent. Time spent in the new state of domicile is one of the most, if not the most, important factors in evidencing intent to change domicile. While there is no bright-line rule to evidence a change of domicile, the following are several steps which an individual may take as supporting evidence of his or her change of domicile:

  • Buy or rent a residence in the new state, sell or terminate the lease of a residence in the prior state, and physically move family and belongings to the new state;
  • Claim a homestead exemption for the home in the new state, and relinquish any homestead claim in the prior state;
  • Change addresses on bank, brokerage, and credit card accounts to the new state and, if practical, change the bank and brokerage account offices used to the local offices in the new state;
  • File a Declaration of Domicile, if available, in the new state;
  • Change driver’s license and automobile and boat registrations to the new state, surrender the driver’s license and registrations to the prior state, and notify the insurance company of the change;
  • Register to vote in the new state and cancel registration in the prior state;
  • Move any safe deposit box to the new state;
  • Move religious, social, and service clubs, and other memberships to the new state;
  • Obtain a library card in the new state;
  • Revise estate planning documents, including Wills, Trusts, Powers of Attorney, and the like, to recite domicile in the new state; and
  • Change your address with the IRS when filing your next tax returns, and file a final income tax return in the prior state indicating the date on which domicile/residency was changed.

To the maximum extent practical, it is important to sever ties with the prior state of domicile. When domicile challenges arise, the challenge usually involves the prior state refusing to recognize the individual’s purported change of domicile, rather than the issue of the new state rejecting a claim of establishment of a new domicile. Nevertheless, even with careful planning in changing domicile, particular types of income can remain taxable in the prior state, such as employee stock options and deferred compensation. If an employee exercises stock options or receives deferred compensation after changing domicile, the prior state of residency/domicile may impose a tax on this income based on the fact that the options and compensation were earned while the employee was resident/domiciled in the prior state.

In conclusion, the impact of a change in domicile/residency on state income taxation must be carefully considered and planning undertaken to minimize state income taxation, while accurately reporting state income taxes among the applicable states. All facts and circumstances become relevant in establishing an individual’s change in domicile, and the best advice is for the individual to focus his or her activity, both economic and social, in the new state.

[*] New Hampshire and Washington tax certain investment income. In considering a change of domicile, consideration should also be given as to whether the individual’s current state and proposed new state imposes a state-level estate tax upon death or gift tax during life. Presently, one state imposes a state-level gift tax (Connecticut), 13 states/districts impose a state/district-level estate tax (Connecticut, District of Columbia, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, and Washington), and five states impose a state-level inheritance tax (Iowa, Kentucky, Nebraska, New Jersey, and Pennsylvania).

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