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.

Even if the state agrees that you are not subject to tax as a resident, nonresidents are subject to tax on income from sources within the state. The rules on allocating income can result in multiple states claiming the right to impose tax on the same income. While the state in which the taxpayer is a resident will provide a credit for nonresident taxes paid to another state, each state will determine the amount of the credit based upon its own laws setting up the potential for conflicts between states and potential double or triple taxation of the same income. For example, most states impose tax on compensation for work performed in the state. However, several states, including New York and Massachusetts, as well as Delaware, Nebraska, and Pennsylvania, seek to impose tax based on the location of the employer where the employee is regularly assigned. In many cases, the taxpayer is caught between two states claiming the income is properly sourced to their state and is not provided a credit since each state applies its law without regard to the other state’s law. 

For example, Massachusetts adopted an emergency regulation implementing a convenience of the employer provision imposing Massachusetts nonresident income tax on employees who regularly worked from a Massachusetts employer’s offices but were working from their homes in New Hampshire during the pandemic. New Hampshire, a state without an income tax on wages, sued Massachusetts in the U. S. Supreme Court on October 19, 2020 (Docket No. 220154) claiming that the Court has original jurisdiction in this dispute between two states and arguing that Massachusetts’ taxing nonresidents working outside Massachusetts is unconstitutional. Fourteen other states have joined New Hampshire asking the court to hear the case and urging the Court to hold that taxing those who are not working within the state is unconstitutional. On January 25, 2021, the Court invited the Solicitor General of the United States to weigh in on whether the Court should accept the case.

As mentioned previously, a nonresident must pay tax to a state if they have income sourced to that state. Every state with an income tax will treat income from real estate located within its boundaries as income sourced to that state. In addition, wages for services performed in the state and income from a business carried on in the state will also be subject to that state’s nonresident income tax.  Consequently, for some taxpayers, there might not be much of a difference in taxes paid as a nonresident. Also, to the extent that a credit is available for taxes paid to another state, there may be little economic effect depending on the circumstances of a particular taxpayer. For those moving to or living in a state with no broad-based income tax (Alaska, Florida, Nevada, South Dakota, Texas, Washington, Wyoming and, as of 2021, Tennessee; New Hampshire taxes interest and dividend income), the credit for taxes paid to another state won’t help.

There could be benefits to filing a tax return as a nonresident. Filing a nonresident tax return will start the statute of limitations running for an assessment for that year. In general, states have three years after the filing of a tax return to audit and assess tax, including a determination of whether a taxpayer is a resident for that year. If no tax return is filed, the tax may be assessed at any time. Those claiming a change in residence who choose not to file a tax return will not have a statute of limitations defense and could face an inquiry or an audit years after the move when records may not be available and incurring substantial interest charges, as well as penalties.

States are gearing up to do audits of anyone with significant income who changes their residency status. For example, New York and California have a history of audits that can go on for years and be intrusive and costly. New Jersey, Massachusetts and Connecticut are increasing their audit activities as well. These audits are not your ordinary examinations that verify taxable income and deductible expenses. Residency auditors will ask about intimate details of relationships, talk to neighbors, doormen, and local shopkeepers to determine where time is spent and verify that information with credit card statements, diaries, appointment calendars and cell phone records.

In the end, you can change residency and, if the proper steps are taken, do it successfully. However, be aware that an audit can take place, and be prepared if that is the case.

Glenn Newman is a shareholder at the law firm of Greenberg Traurig LLP.