Pandemic-related lockdowns have forced some wealthy taxpayers to remain in one location longer than they intended when the year started. This comes just as residency audits become a greater tool for tax agencies to generate additional revenue.

Lockdowns might intensify risk of a special kind of state-level audit. “People unable to leave a higher-tax state, where they own a home, may well face added risk of a residency audit,” said attorney Brandon Smith, director of the integrated planning group at Summit Financial in Parsippany, N.J.

Residency audits can result in state taxation of a taxpayer’s worldwide income, whether it was sourced in that state or not. State auditors may uncover claims by analyzing credit card charges, home utility bills and social media postings, among other clues. “Clients often have the misconception that they can claim residency elsewhere simply by having a home in a lower or no-tax state,” said Shane Glass, president of The Colony Group's business management division and managing director of their Los Angeles-based office.

“High-net-worth clients with sophisticated tax advisors are well informed, but the challenge is in the implementation,” said Suzanne Shier, wealth planning practice executive and chief tax strategist at Northern Trust Wealth Management in Chicago. “A significant misconception is the impact of continuing to own residential real estate in the state clients are leaving. Continuing to own residential real estate is a red flag. Another consideration is making a domicile election in the state one is moving to.”
 
For example, an individual is deemed a New York resident if they spend more than 183 days in a year in the state. “Absent Covid-19 symptoms requiring hospitalization in New York, it’s unclear whether days spent in New York simply due to shelter-in-place orders or travel restrictions would fall within the exception,” Glass said, adding that California is aggressive in claiming out-of-state taxpayers as residents.

Medical emergencies can create an exception to the threshold, but other guidance from this and other states has been scarce so far. Some states exempt days spent receiving hospital care from counting as a day’s presence, Smith added. Some states also agree with other jurisdictions in the area to minimize duplicative taxes and non-resident returns for cross-border workers.

“The actual triggering event occurs when a non-resident maintains a permanent place of abode in the subject state. Once the audit is triggered, the actual number of days spent in the state becomes relevant,” said Tom Corrie, principal and director of state and local tax at Friedman LLP in New York. “This type of audit focuses on statutory residency, where a non-resident is deemed a resident if certain criteria are met.”

Tax authorities can also claim someone is domiciled in a state based on the location of connections: selling a business, large stock holding or highly appreciated asset shortly after moving, for example, or maintaining a different state of residence than a spouse. “If you’re claiming residency in Nevada after you have moved away from California, you better change your driver’s license and voter registration to be in Nevada,” said Robert Seltzer, a CPA at Seltzer Business Management in Los Angeles. 

“Owning homes in two or more tax sites like this, coupled with spending significant time in those tax sites during any year, gives higher-tax states a justification for auditing someone’s residency,” Smith said.

“A person can have numerous residences at a time but only one domicile, the place one intends to have as their permanent home and maintains social, political, financial, tax and legal connections," added Glenn DiBenedetto, director of tax planning at New England Investment and Retirement Group in North Andover, Mass. "If you maintain residences in two or more states and don’t meet the physical presence threshold in any one state, one or more states may look to tax your income.”

State tax credits might appear to head off double taxation, said Tim Speiss of the private wealth group at EisnerAmper in New York. Some states have already provided guidance that they will not enforce their state tax rules for remote workers. Others are debating similar legislation.

“The rules can be complex and we expect to see many examples in 2020,” Speiss added.