Before moving from a state or establishing a second home, know how the state you currently reside in will react. States with net losses of residents are developing innovative and aggressive ways to capture tax revenue from their expatriates.
The most recent innovation is the “exit tax” imposed on departing residents.
A proposed wealth tax in California would tax residents and businesses with annual incomes exceeding $30 million ($15 million for married couples filing separately). They would have to pay a tax of 0.4% on their net worth exceeding the trigger amount and could be liable for the tax up to 10 years after leaving the state.
Even people worth less than $30 million should be worried about this. Once the tax is enacted, it would be easy for the state to reduce the threshold amount.
Some real estate holdings would be exempt from the exit tax, but gains on those properties already face state capital gains taxes when sold.
The exit tax would allow the state to reap taxes on stocks that appreciated occurred while a person was resident in California but wouldn’t be sold until the owner left California.
In New Jersey, gains on the sale of real estate become immediately taxable if the seller is leaving the state, even if the gain would be exempt for a resident. The tax is estimated and collected at the closing of the sale.
Some states have been successful at taxing deferred compensation that a person earned while a resident but didn’t receive until after leaving the state.
They’ve also taxed stock compensation, whether in options or shares, when the securities aren’t sold until after the individual leaves the state.
Some of these states tell employers they have to withhold state taxes when deferred compensation is paid, even when the payee has left the state. Then, the recipient has to decide whether to file a tax return to try to claim a refund.
I’m not aware of any state that has successfully taxed 401(k) distributions or pension annuities of former residents. But there are some state legislators who discuss the possibility.
California has successfully argued that nonresidents owe California state taxes on income earned by businesses they own that have a “situs” in the state. A situs doesn’t have to be a location. It can be other contacts.
State tax departments aggressively use technology to identify and investigate people who claim they moved.
After someone stops filing an income tax return or switches their tax return filing status from resident to nonresident (or part-time resident), certain programs automatically are triggered.
A state can examine cell phone use, credit card charges, toll road charges, and other data to get an idea of how much time a person still spends in the state.
Other important databases include driver’s licenses, vehicle registrations, real estate ownership, and business and professional licenses and registrations.
These actions are the beginning of a residency audit. After the information indicates the state could argue the person hasn’t really moved, a lengthy questionnaire is sent to the individual.
The questionnaire asks for details about travel during the year, property ownership, business and personal activities, and more. A residency audit letter and questionnaire indicate it’s highly likely the state has done significant research.
Your defense is to show that you severed all or most ties with the old state and centered your life around the new state.
Some states have a bright line rule. If you’re in the state for more than 183 days in the calendar year, then you’re a full-time resident and taxed on all income. Otherwise, you’re taxed only on income earned while working in the state.
Some states count only days you were present for a full day, while others count a full day when you spent any time in the state, even only a few hours on a travel day.
If you travel at all to the old state, maintain logs or calendars that list where you were each day of the year. Keep receipts and other records that back them up.
Instead of the 183-day rule, other states impose taxes based on a person’s domicile, which is the place a person intends to maintain a permanent residence or abode indefinitely. It’s a subjective test in which facts and circumstances indicate your intent.
The review begins with the 183-day rule. But under the domicile standard, you can spend only a few (or even zero) days in a state and be considered domiciled there unless the facts show you intended to establish a new domicile.
The key is to reduce or eliminate contacts with the old state. The more contacts you maintain, the greater the likelihood that you’ll be viewed as a domicile.
Continuing to own a home or business in the old state is a significant contact that can override other facts. It’s safest not to own or even rent a home you can return to in the old state. Also, don’t be more than a passive investor in a business located in the state.
Your driver’s license, auto registrations, voter registration, and church and club memberships all should be changed.
Many states won’t consider a move permanent if memberships are switched to inactive, nonresident, or associate status instead of being resigned or transferred. They say the change is temporary and you easily can switch back to full or resident membership.
Some states expect you to give up professional licenses in their states or at least obtain new ones in the new state.
It also is not a good idea to leave valuable property such as jewelry, furs, and art in the old state. Many states consider the presence of valuable items, even in storage, a significant contact that triggers taxation.
A common mistake is to keep a boat or vehicle registered in the old state because the property taxes or registration fees are lower.
Another mistake is to tell the state you’re a passive investor in a business but assert active investor status on the federal income tax return, where it can result in big tax savings.
Another bad ploy: Tell an insurance company you are resident in one state because premiums for its residents are lower but tell the state you are resident elsewhere.
An aggressive state will look for such inconsistencies. Inconsistent actions could trigger fraud penalties in addition to a tax bill.
Recordkeeping is important, because a state can spring this trap on your estate after you have passed. For some states, the big payoff is from their estate or inheritance taxes. When you no longer are around to testify and help gather evidence, the state can swoop in and assert claims against your estate.
Cities and counties with income taxes use the same tactics to retain tax dollars.
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