Moving to Escape State Tax?
Could You Pass the “Teddy Bear” Test?
Are you a Northerner looking to flee to Florida to soak up sunshine and beat state income tax? Tax reform in the New York tri-state area hit high-earning residents with a new $10,000 cap on the federal tax deduction for state and local taxes. Studies show the new cap on the so-called SALT deduction will increase New Yorkers’ federal taxes by $14.3 billion in 2018 alone and another $121 billion between 2019 and 2025. New York, New Jersey, Connecticut and Maryland feel unfairly targeted and are suing the Trump Administration, but what happens in the meantime? Should you move your business? Your family?
Leaving a Northern State for Florida sounds like a no-brainer, yet entrepreneurs should be cautious. It’ll take more than just changing the address of your headquarters. The issue of “tax nexus” and where you actually conduct your business matters to states reluctant to give up revenue and may make the difference between a headache or an opportunity when it comes time for you to pack up and move.
Establishing a tax nexus is based on a number of factors, including where your employees are, where your property is located and whether you have inventory in a particular location, where you ship, or where services are provided. Based on the nature of your business and these factors, your company may be required to pay income and sales taxes in a new location. Things are even more complex for a business with multiple locations and wide client base; you may have to file in more than one state. Some states base taxes on where the work is performed, while others tax businesses based on where the customers are located.
Maybe you and your business can easily flee to a state with lower taxes. In any scenario, you’ll need to establish domicile — your true permanent home — in that new state to benefit from their friendlier tax environment.
Domicile is harder to establish than you might think – it takes more than a new driver’s license and post office change of address form. Tax collectors in states like New York hate to see your tax dollars vanish and so they make it really hard to prove that you’ve left for good. Tax collectors aggressive tactics to prove residency are legendary. Auditors have been known to scour credit card statements, bank transactions, travel and phone records to track a taxpayer’s location.
So what hoops should you be expected to jump thru? If you are a New Yorker, there are two main hurdles, the domicile test and the 183-day rule. There is no rule against maintaining several “residences,” but you can have only one “domicile”—the place you always call home and the place where you always intend to return. Regardless of “intent,” New York considers an individual a resident for tax purposes if they “maintain a permanent place of abode” in New York, “and spend more than one hundred eighty-three days” a year there!
The domicile test examines 5 primary factors:
1. The new home itself – auditors look carefully at the size, the value, use of each residence, and what domestic employees work at each location. If a taxpayer claims to be selling their New York home, the auditors will look for contracts with real estate brokers and ask the taxpayer to prove that he or she has really moved out. They make no distinction between owning and renting.
2. Business activities in your new state – Nonresident audits are often aimed at entrepreneurs who claim to have “sold” their business to children or other insiders, retired, and moved to Florida. Auditors will look carefully at continuing “active participation” and/or any “substantial investment in, or management of” that business as well as any active role in daily decisions. Constant communication with management, customers, or vendors could be evidence of involvement. Auditors will ask for phone and email records, and correspondence in trying to determine intent to continue operating a New York business. Limit the time you are actively engaged in a business enterprise located in your old domicile, or risk the state taking the position that your domicile has not truly changed.
3. How is your time spent there – Even if you pass the statutory residence test, auditors will analyze the time spent in New York relative to other locations.
4. Where favorite possessions kept (the “Teddy Bear Test”) – If a person moves to Florida but leaves behind sentimental possessions or heirlooms, artwork, rare books or antiques, which add quality to the individual’s lifestyle, the auditors will most likely ask for insurance policies, and other records to show where these items are actually located during the year.
5. Family ties – The state will take an unfavorable view of family members such as a spouse or minor children left behind in your former state for long periods of time. Refrain from commitments to spend as much time as possible in your former state with children and grandchildren. Auditors are cautioned to not be intrusive and avoid this analysis unless it is absolutely necessary.
The 183-day rule test looks at:
1. Whether you moved but still hold on to your family home in NY,
2. Proof you have not spent more than 183 days in the state per year,
3. Documentation of time actually spent in New York over the course of a year.
What makes you a target for a domicile audit? Moving immediately after selling your business, getting a huge severance package, or another sizable spike in income. Also whether or not you spend 182 days in New York every year! Taxes are generally subject to a three-year statute of limitations from when a return is filed, but spending extra time in New York each year after the birth of a grandchild might trigger an audit. Remember auditors are watching your “lifestyle.”
Key Point: Clients may not realize the problems that can arise from a vacation home in another state, a convenience apartment in Manhattan, or snowbird lifestyle in New Jersey and Florida. Second homes offer convenience and luxury but significant tax issues arise when more than one state considers you a resident for income tax purposes.
Clients who are found to be domiciled in a state other than their declared home state, or who have met certain thresholds based on their travel and time spent in that additional state, are at risk of being taxed on all of their income. That also includes passive income like interest and dividends, capital gains and other income, regardless of whether they are derived from activities in the declared home state.
Contact Us: Taxpayers may not appreciate how easily they could find themselves subject to multistate-residency taxation, that is why we proactively request pertinent tax and financial information related to domicile and residency, and ask clients to maintain proper records and documentation in order to protect themselves. When it comes to residency issues, we work to ensure clients are not at risk of an audit after filing their returns. Accordingly, if a client does have a second (or third) home out of state, we ask they provide information about how and where they spend their time. With offices in New York and Florida, we are uniquely qualified to discuss decisions regarding relocation related to tax issues and the details of “domicile” auditors look for. Questions? Contact Fuoco Group accountants and business advisors toll free: 855-534-2727.
