According to CNBC, New Jersey, New York, California, Connecticut and Illinois are the five states that had the most residents move away in 2020; they are also among the states with the highest state and local taxes. That is of significance because this shift may have started to occur after the Tax Cuts and Jobs Act of 2017 limited the federal deduction of state and local taxes to $10,000. Those with substantial state or local income taxes or who owned multiple homes and had significant property taxes considered relocating to lessen the impact of the limited deduction that used to defray up to 35-40% of the cost of those state and local taxes. Then, the Coronavirus Disease (Covid-19) pandemic hit, disrupting normal work routines, emptying offices and causing people to begin to work remotely.
Over the course of this year-long pandemic and as a result of the transition to working at home, people retreated to their vacation homes or rented homes in places with lower infection rates or where they felt more comfortable sheltering from the virus. Now, it is time to prepare to file state tax returns. While there are federal tax issues involving Paycheck Protection Program (PPP) loans and some tax relief in the Coronavirus Aid, Relief, and Economic Security (CARES) Act, the questions regarding filing state tax returns should not be overlooked.
Consider the following:
• Are you now resident in a different state than you had been due to the changes in where you spend time or where you work?
• Are you now a resident of more than one state based upon extended use of a vacation home or because you rented a place in another state?
• Are you now subject to filing a non-resident tax return in a state because you performed services in that state or had income sourced to the state?
• How is your income properly allocated to the states?
To answer these questions, one must understand that a state can tax its residents on all income regardless of its source. However, states are constitutionally restrained from taxing nonresidents’ personal income, except insofar as it is derived from sources within the state. In general, state sourced income includes income from work performed in the state, income from real estate located within the state and income from a business carried on in the state. The difference means that a nonresident would not be subject to state tax on income from intangibles, including interest, dividends and gains on the sale of stock, partnership interests or interests in limited liability companies unless the intangible asset was used in a trade or business operating within the state.
So how do states determine who is a resident and who is a nonresident for income tax purposes? A person can be taxed as a resident of the state where they are domiciled or if they are statutory residents of the state.
Domicile is defined as the place where the taxpayer has a true, fixed, permanent home, or the principal place to which the taxpayer intends to return whenever absent; a person can have only one domicile even though they may have many residences. Domicile includes an element of intent to establish a fixed presence in the state. To determine the intent to establish a domicile, states look at various factors such as the size, value, and use of a home if the taxpayer has more than one home and how much time is spent in each location. While the formalities of changing drivers’ licenses, car registrations and voter registrations are necessary, they will not be determinative. The states will also examine active business involvement in the state; the location of “items near and dear” to the taxpayer, including heirlooms, family treasures, whether they have monetary or emotional value and family ties to the state. Each of these factors will be evaluated to see what location has the most substantial connections. The law is clear that once a domicile is established, there must be clear and convincing evidence that one has severed connections to the old domicile and established roots in the new domicile. Keeping the historic home or staying actively involved in a business located in the old domicile could be problematic.
Since domicile is a subjective determination of intent, state laws provide for statutory residency that subjects one to resident income tax based on objective verifiable facts: 1) whether the taxpayer maintains a permanent place of abode in the state and 2) spends more than 183 days in the state. In New York, for example, once one is subject to a day count audit, any part of a day spent in New York (other than for interstate or international travel and days confined to a medical facility) counts as a day. In addition, days lacking documentation pinpointing the taxpayer’s whereabouts may be counted as New York days.
For those who sheltered from the virus in their vacation home or rented a home in a state other than their domicile, a day count approaching 183 days can put them at risk of being a statutory resident of another state. In Matter of Nelson Obus, (New York State Tax Appeals Tribunal, decided January 25, 2021), in which I represented the taxpayer, a vacation home in the Adirondacks more than 200 miles from the taxpayer’s New Jersey domicile and his New York City workplace used, at most, a few weeks a year was found to be suitable for year-round use and therefore was a permanent place of abode making him subject to resident income tax in both New York and his New Jersey domicile.