The Tax Cuts and Jobs Act (TCJA) was signed into law on December 22, 2017 creating changes to the federal tax code beginning January 1, 2018. One of the changes in the TCJA, the limitation of a deduction of state and local taxes, is expected to cause an increase in state and local income tax audits. These audits will be designed to determine if a taxpayer is a resident of a specific state or locality and subject to income tax in that state or locality on all of the taxpayer’s income. These audits are often referred to as residency audits.
The introduction of a limit at the federal level for the deduction of state and local taxes (SALT) was one of the changes to the Internal Revenue Code under the TCJA. Under prior law, individual taxpayers who itemized federal income tax deductions could generally deduct all state and local income taxes as well as property taxes. For many taxpayers residing in high-tax states such as California and New York, this SALT deduction was often one of the largest itemized deductions. Under the TCJA, the SALT deduction is now limited to $10,000 ($5,000 for married taxpayers filing separately). For high income taxpayers, this limitation will significantly reduce a valuable deduction.
This provision of the TCJA may lead to high income taxpayers in high income tax states, such as New York, to relocate to states that have lower income tax or no income tax, such as Florida. If taxpayers make such a move, they need to consider the tax residency rules that apply. Taxpayers should be aware that a move to a low or no tax state may be scrutinized and lead to a residency audit by the state from which they are moving.
In general, a state and local income tax is applied to all income of resident taxpayers. For example, a New York City resident is subject to New York State and New York City tax on worldwide income. This is true even if the income does not originate from New York sources. Taxpayers who are not residents of New York are generally taxed only on their New York source income. Whether an individual is a resident of a particular state will ultimately determine whether that state can tax the individual on all of the income, or only the income generated from that state.
In New York, a taxpayer is deemed to be a resident for tax purposes if the taxpayer is domiciled in New York or qualifies as a statutory resident. A taxpayer’s domicile is generally the place where the taxpayer intends to have his permanent home and the principal place to which the taxpayer intends to return. A taxpayer’s domicile is essentially determined by the taxpayer’s intentions and is a subjective determination. Once a taxpayer has established a domicile, the location continues to be the taxpayer’s domicile until the taxpayer leaves it and moves to a new location with the intention to make the new location a permanent home.
Taxpayers leaving a high income tax state need to establish that they have abandoned their old domicile and have established a new domicile in a different, low income, state. Determining domicile is subjective and requires determining a taxpayer’s intentions. In order to determine the taxpayer’s intentions states will look at the taxpayer’s conduct and actions in order to determine the taxpayer’s intentions. The taxpayer is the one required to prove the change of domicile.
Taxpayers making a change in their domicile will need to take actions that demonstrate their intentions. New York uses five primary factors to measure a taxpayer’s intention:
• The size, value, and nature of use of the taxpayer’s former New York residence compared to the size, value, and nature of use of the residence in the new state of domicile
• The taxpayer’s employment and business connections in both states
• The amount of time spent in both states
• The physical location of items that have significant sentimental value to the taxpayer
• The taxpayer’s close family ties in both states
All of the factors are weighed individually and collectively. No one factor will be the determining factor.
In addition to these factors, states will often look at many other factors that can establish to the taxpayer’s intentions. An audit to determine a taxpayer’s domicile can be intrusive and will require the presentation of information regarding very personal aspects of the taxpayer’s life. During residency audits taxpayers can expect inspections of their personal diaries and calendars, EZ-Pass records, cell phone records, credit card usage and other intrusive methods of examination.
Even if taxpayers can overcome the change of domicile factors, the taxpayers must also establish that they are not statutory residents of the state. In New York, an individual is a statutory resident if the taxpayer maintains a permanent place of abode in New York and spends more than 183 days in New York during the tax year. For purposes of this test, a permanent place of abode is any dwelling available to the taxpayer in a residential capacity for substantially all of the tax year. For purposes of meeting the 183 day threshold the taxpayer does not have to visit the New York abode, the taxpayer only has to visit New York. The statutory residency is measured on an annual basis and taxpayers who are statutory residents of a state may be subject to repeat audits to determine their status for each tax year.
While the examples in this article use New York State residency rules, many other states use similar rules to determining residency status. Taxpayers moving from a high income tax state should be certain that they document their movements and clearly demonstrate that the move is permanent.