Why Dealing with State Tax Issues Boils Down to Domicile
My main office is in Florida and as part of the Constitution in this state, there is no individual income tax, as well as six other states.
For Florida, we deal with a lot of “snowbirds,” which are basically people who spend the winter months in Florida and return to their northern home state during Florida’s oppressive summer. This can make a snowbird’s income tax situation complex.
The real question becomes: How does a snowbird demonstrate Florida residency for income tax issues?
As of 2017, there are seven states that don’t have a personal income tax. They are:
- South Dakota
In Florida, residency is created by filing for a homestead exemption. For property taxes, a homestead exemption makes the first $50,000 of your homestead nontaxable for property taxes. Further, we have something called Save Our Homes, which caps the increase in the valuation for property tax to a 3 percent increase in valuation per year. It’s a pretty lucrative taxing regime that most people in the state take advantage of.
As per the rules of the homestead exemption, you can only apply for the designation on one of your properties. If you have more than one home in the state, you must only choose one property.
But what does this exemption do for state taxes?
Most states that have a personal income tax have a function whereby the taxpayer can file as a full-year resident, partial-year resident, or a nonresident. Each state has its own rules as to when these filing statuses can be used.
Most snowbirds have two tax homes: one in Florida and another in their home state. They split their time between the two states. That being said, the snowbird has created two nexuses: one in the state that doesn’t have a personal income tax, and the other from their home state, which does have a personal income tax. Therefore, the income that has been earned in the other state is usually taxed at the lesser, part-year resident’s status.
However, what if there was a way around the oppressive state tax rules?
Let’s use the state of New York as an example. New York domiciliaries pay state income taxes on all income earned. Florida domiciliaries pay New York income taxes only on income derived from “New York sources,” like rent received from a building owned in New York state.
In an audit, taxpayers have the burden of showing by “clear and convincing evidence” that they had the intention of moving to Florida permanently, not simply that they went through the motions of getting there. You can have several “residences,” but only one “domicile” – the place you always call home and the place where you always intend to return.
Intent is a very subjective test, but auditors in New York (and to a lesser extent other states with income taxes and estate taxes) use written audit guidelines to help them determine taxpayer intent.
Sometimes, though, auditors don’t even have to reach the issue of taxpayer intent. New York has a “statutory residency” provision (Tax Law Section 605(b)) that says, regardless of your “intent,” you’re a New York state resident for tax purposes if you “maintain a permanent place of abode” in New York, “and (emphasis added) spend more than one hundred eighty-three days” a year there.
In trying to arrive at a taxpayer’s intent, the guidelines direct auditors to examine five “primary” factors:
1. The home. While the guidelines stress that “retention of a residence in New York is not, by itself, sufficient evidence to create a change in domicile,” auditors are told to look carefully at the size, the value, and the nature of use of each residence, in addition to analyzing what types of “employees” (domestic help, groundskeepers, chauffeurs, etc.) are utilized at each location. If you claim to be “selling” your home in New York, you will undoubtedly be asked to produce proof that you have really moved out, as well as contracts with real estate brokers and the like. There’s no distinction between owning and renting.
2. Business involvement. Numerous nonresident audits are aimed at entrepreneurs who claim to have “sold” their business in New York (to their children or other insiders), retired, and moved to Florida. If you are in this position, auditors will look carefully at your continuing “active participation” and/or any “substantial investment in, or management of” that business; and also your “active role in day-to-day decisions.” Remaining “in constant communication” with new management, customers, or vendors can weigh against a taxpayer asserting a change of domicile. Auditors will ask for phone and email records, correspondence, and other evidence of your involvement with the New York business in trying to determine your intent.
3. Time. You have “passed” the 605(b) test, but auditors are still told to look at a “quantitative analysis of time spent in New York in relationship to….” other locations. You would be a target of this factor if, for example, you spent about 5-6 months in Florida for many years and then, without changing much else, you went to 7 months in the year you claimed a “change” in domicile.
4. Items near and dear. This is sometimes referred to as the “teddy bear rule.” If you move to Florida but left behind your “sentimental” possessions (family heirlooms, works of art, books, antiques, family photo albums, etc.) which “enhance and add quality to the individual’s lifestyle,” the auditors will ask for bills of lading, insurance policies, and other records to show where the items are actually located during the audit years.
5. Family connections. If you, like one taxpayer admitted in a losing case, express a “commitment” to spend “as much time as possible” in New York with children and grandchildren, this factor could tip the balance in a nonresident audit, even though auditors are cautioned to be aware of the “intrusive nature” of the factor and to avoid the analysis unless it’s absolutely necessary for their determination. (Snowbird, or the real deal?)
The obvious way out of being deemed as domiciled in New York is to spend less than 183 days in New York state. The time factor is not special to just New York, either. Most states have some measurement of time that precludes a resident of both states from not creating an individual taxing nexus.
For my clients who are snowbirds, I advise them to be physically present in Florida from October until the end of May. That is more than 183 days away from their other state. Further, applying for the homestead exemption in Florida shows intent on making Florida their tax home.
Being domiciled in a state for tax purposes requires some planning. However, there are mechanisms in place for each state to avoid the other state from imposing an income tax.
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Craig W. Smalley, MST, EA, has been in practice since 1994. He has been admitted to practice before the IRS as an enrolled agent and has a master's in taxation. He is well-versed in US tax law and US Tax Court cases. He specializes in taxation, entity structuring and restructuring, corporations, partnerships, and individual taxation, as well as...