A $1 million-plus New York state tax decision is raising startling questions about how much clients with homes in more than one state can wind up owing in state taxes.
In January, the New York Tax Appeals Tribunal largely rejected the petition of a couple who argued they were Connecticut residents and made only brief visits to their second home near the Hamptons. The $1,055,848.05 state tax assessment applies to the three years for which they were audited.
At issue in the decision was whether the couple, John J. Barker, who worked in New York as an investment manager for Neuberger Berman, and his wife, Laura, had spent more than 183 days in New York for each of the audited years-2002, 2003 and 2004. The couple's New York home during that time was used by family members.
"This case is scary for Floridians, who, while they knew they had to be careful regarding the typical residency factors, would never figure that New York would go this far!" Michael Lampert, a West Palm Beach, Fla., tax attorney, says. "What is even more interesting is that New York imposed penalties."
Actually, the tax tribunal decision in the Barker case leaves open the prospect of a waiver of the $221,086.01 in penalties. The couple's New York attorney, Timothy P. Noonan, says the penalty issue has been remanded to an administrative law judge for reconsideration. Following that, an appeal of the tribunal's decision to the appellate division of the state court system in Albany will be considered. Next, the appeal could go to the state Court of Appeals and after that to the federal courts.
But despite the attention this case is generating, experts say not much is new. Martha Stewart lost a similar argument in January 2000 that her home in East Hampton was merely a summer home, and she had to pay $221,677.82 in back state taxes plus interest to New York tax authorities.
And there are other similar cases you never hear about, says Verenda Smith, acting interim executive director for the Federation of Tax Administrators, Washington, D.C. "You will find much the same thing going on in Iowa with farmers," she says.
High state tax bills have also roiled those with extra homes in California, Nevada, Arizona and Hawaii. The Barker case merely underscores the need for those with residences in multiple states to pay much greater attention to tax laws. They need to spend time with a good income tax lawyer who has expertise in residency and knows the rules in those states, Smith warns.
Advisors might want to take their cue from what goes on in New York, since the Empire State is one of the toughest for audits.
New York long has applied two tests for residency, by determining: 1) whether a person has a permanent place of abode in New York for more than 183 days of the year, and 2) whether the residence is accessible almost all year.
A major problem in the Barker case and others in New York is that the state has been judging those two standards independently, says Arthur R. Rosen, co-chair of the New York tax matters committee of the New York State Bar Association. Furthermore, the second condition is not very clear. To document that a client's New York home is not accessible, Rosen would advise clients to "legitimately" rent it out for a few months each year. But even that's not exactly airtight.
The position of the New York State Department of Taxation and Finance is that to be considered a permanent residence, the home needs to be maintained almost the entire year-around 11 months, Rosen explains. "One might thus assume that renting out the premises for a little over one month would suffice. However, the department has made it clear that repeated annual short rentals will not be respected. Thus, there is no easy answer that the department will clearly accept."
Rosen adds that the burden is typically placed on the taxpayer to prove that the state taxes are not owed.
Meanwhile, beware residency laws that are different in each state. Also, double taxation-taxation by two different states on the same money-can easily occur.
In fact, Sanford J. Weinberg, a Stamford, Conn., tax attorney, says that if the New York tax decision holds, the Barkers will likely wind up getting taxed on their unearned income-such as dividends, capital gains and interest-by both New York and Connecticut!
Luckily, however, Connecticut gives you 90 days after a tax verdict in another state to seek a credit on Connecticut income taxes already paid-even after its statute of limitations expires.
New York rules, Weinberg notes, are not as liberal. It's critical, Weinberg says, that clients with multiple homes monitor the number of days spent in New York for that state's income tax purposes. "That can be painstaking," he says. One CEO client who maintains residences both in New York and New Jersey, he says, goes so far as to cross the George Washington Bridge from New York and New Jersey at 12:01 a.m. the day before he'd be deemed a New York resident. This way his E-ZPass statement clearly documents non-residency.
Financial advisors too often suggest that clients document residency in a particular state by obtaining that state's driver's license and voter registration. However, that's likely not enough for a comprehensive audit.
Good records might include a report summary of frequent-flier accounts; credit card receipts documenting the trip between homes; or phone records. If a client is sharing a private jet, formal logs may prove acceptable.
Clients who fail to hang on to such records could have a big problem. That's because companies like airlines typically keep records for only 18 months, Rosen says. And New York state tax audits could begin at least four years after a client has filed a tax return.
Does your client have a residence but no income in that state? Even so, he or she should permanently keep frequent-flier and credit card records in case the state has questions, he suggests.
Also, once a state determines that a client is a permanent resident and owes that state income taxes, be prepared for that state to go after estate taxes when the client dies!