“Home is where the heart is.” Or at least that’s what they say. When it comes to state income taxes and other legal matters (from family law to asset protection), though, home is where your domicile is… whether your heart – or your body – is there or not.
Fortunately, for many or even most people, determining domicile is rather straightforward – it’s the state in which you live in your one and only residence. But technically, domicile is a person’s fixed, permanent, and principal home that they reside in, and that they intend to return to and/or remain in. Which means for those who have multiple residences, or may be living somewhere else temporarily, where they live may not actually be their domicile.
In fact, it can be remarkably difficult to determine domicile for those who have multiple residences in multiple states, because the key factor is the “intent” of the individual, which isn’t always able to be known clearly. Accordingly, individuals who wish to change to a new state of domicile and don’t clearly leave and sever ties with a prior state of domicile can run into problems, with the old state challenging the change of domicile based upon a perceived lack of intent. Thus, even though a person can technically only have only one true domicile, two states may each believe that single domicile is their state!
In addition, even if an individual does not have domicile in a particular state, maintaining a residence in a state and using it for extended periods of time can trigger “residency” status in that non-domicile state as well, under the “statutory resident” rules. Which, ironically, means that multiple states may claim an individual as a resident under statutory resident rules.
And ultimately, knowing which states an individual is a resident of – whether triggered by domicile status or as a statutory resident – is crucial, because any state in which the individual is a resident has the right to tax that individual on all income worldwide. Which means if residency is triggered in multiple states at once, worldwide income may be subject to income tax in any/all of those multiple states (though certain offsetting credits for taxes paid to another jurisdiction are generally available).
As a result of these rules, determining domicile and the state (or states) of residency for tax and other legal purposes requires not just careful consideration of which state(s) the individual wants to reside in, but the exact rules that each state uses to determine domicile (and/or statutory residency), and that in the end changing state of domicile isn’t just about meeting an arbitrary time-based test but actually showing and being able to prove the intent to live in a particular new state (for which individual behaviors, from voting to driver’s license registration, using local service providers and even moving your pet, are crucially important), along with showing intent to sever ties and not live in the prior state as well!
(Michael’s Note: This post was written by Jeffrey Levine, CPA/PFS, CFP®, CWS®, MSA. Jeff is the Director of Advisor Education for Kitces.com, CEO and Director of Financial Planning for BluePrint Wealth Alliance (where he drives the firm’s vision of delivering a unique, modern approach to the financial, tax, and estate planning), and is the Lead Creator and Content Expert for Savvy IRA Planning®, offered through Horsesmouth. Jeff is a recipient of the Standing Ovation award, presented by the AICPA Financial Planning Division, and was named to the 2017 class of 40 Under 40 by InvestmentNews. Previously, Jeffrey served as Ed Slott and Company’s Chief Retirement Strategist, where his ability to simplify the complex laws that govern individual retirement accounts, combined with his unique blend of humor and tax planning, was first recognized. Jeffrey continues to be an active speaker, traveling the country each year to educate thousands of Financial Advisors, CPAs, Attorneys, and consumers on retirement, tax, and estate planning strategies. You can follow Jeff on Twitter @CPAPlanner and via his personal website.
Domicile Vs. Residence
The terms “domicile” and “residence” are often used interchangeably, but from a tax and legal perspective, they are not the same.
Functionally, having “domicile” in a state means that state’s laws will apply to the individual who is domiciled there, from the state’s right and ability to tax that person for state income tax purposes, to the individual’s right and ability to rely on that state’s laws (e.g., for asset protection purposes).
The precise definition of what constitutes “domicile” varies slightly from state to state, but states generally agree on two key concepts: that a domicile is a person’s fixed, permanent, and principal home that they reside in, and that they intend to return to and/or remain in; and that while a person can have multiple residences, they can only have one domicile. Which is important, because an individual may be living in a certain residence for a temporary period of time – even an extended period of time – but if it’s not the place they ultimately attach themselves to and intend to return to, it’s still not their domicile.
The Biggest Challenge Of Establishing Domicile: “Proving” Intent
The challenge in determining domicile is that it is based heavily on the deemed intent of the individual. Domicile is an individual’s permanent, fixed, and principal home to which he/she intends to return and remain.
When someone only has one home, it’s generally pretty easy to determine domicile – the state in which they reside is in the state in which they have their domicile. However, if an individual has two homes in different states (e.g., homes, apartments, condos, and/or other places to live) that they reside in for alternating periods of time, they may “reside” in two states, but they will still only have one “domicile” – the primary location in which they live.
If you’re like many people, you might think it comes down to answering a question like, “In which state did I spend the most amount of time?” While that may determine (statutory) residency, it isn’t the most critical element when determining domicile. Rather, the key factor is actually intent.
“…the principal home to which you intend to return and remain.”
Here’s the problem with intent though… the only one who can truly know your intent is you! And while you may find this hard to believe, there are some people out there who would – hold on to your hats – lie about their intent in order to claim a more “favorable” domicile state that might lower their taxes or provide other benefits tied to having their domicile located in that state.
Say it isn’t so!
The determination of a person’s intent, therefore, is necessarily left up to an outside individual (i.e., a revenue agent, judge, etc.), which introduces subjectivity into the determination process. Which means it is up to the individual to “prove” that they have changed domiciles. And to make matters worse for those trying to change domiciles, there is generally a presumption that there has been no change of domicile unless clearly proven otherwise.
Thus, when it comes to making the move and changing domiciles, the best advice is often to treat a former domicile like a bad “ex”; just cut ties and leave for good. But just walking away from an old flame “cold turkey” can be difficult, and so too can abandoning ties to a state where one has spent the better part of their life.
Becoming A Statutory Resident Despite Having Domicile Elsewhere
The fact that a “domicile” is a primary residence that an individual maintains and/or plans to return to means that individual is deemed to be a resident for tax purposes of the state of domicile. Which for most people is rather straightforward, because the primary residence in which they live really does constitute both their state of domicile and the state in which they are a resident for tax purposes.
However, even if an individual is domiciled in another state, if he/she spends “too much” time in a second state, the second state can also claim that the individual is a “statutory resident” (i.e., a resident because of the state’s “statutes” or laws, regardless of their demonstration of intent) of their state as well, and tax him/her accordingly.
In other words, a statutory resident is someone who is not domiciled in the state, but nevertheless, is considered a resident of a state because they have met certain conditions under that state’s laws (i.e., their “statutes”) that dictate they be treated as a resident. States have the ability to control who they deem as a resident, so theoretically, a state could say, “Hey! If you spend more than 10 days in our state and breathe the air while you’re here, we will consider you a resident of our state.”
And what if you don’t like that state’s definition of residency? Don’t visit that state for more than 10 days (or hold your breath while you’re there)!
Thankfully, state laws aren’t that draconian, but if you’re planning to spend an extended (e.g., multi-week and especially multi-month) amount of time outside of your state of domicile, it’s a good idea to check out your destination-state’s residency rules.
Many states, such as New York and New Jersey, consider an individual a statutory resident if they maintain a home in that state for all (or most) of the year, and they spend at least half the year (184 days or more) within the state (while other states may use a different threshold of 200 days or some other period of time). And if you meet those “statutory resident” guidelines by staying “too many” days in the state, then – absent some sort of special exemption (such as those provided to certain members of the military, and their spouses, under Servicemembers Civil Relief Act and the Military Spouse Residency Relief Act, respectively) – you are a resident of that state. There are no “ifs”, “ands”, or “buts” about it.
Other states, on the other hand, don’t use a days-in-the-state test for residency. Illinois, for example, has no precise statutory resident rules at all but will consider someone a resident if they deem them to be in the state for other than temporary and transitory purposes. Similarly, in California, there is no statutory resident provision of the law, but if you spend more than nine months there in any one year, they will presume you are a resident, and it’s up to you to prove otherwise (good luck with that!).
The reason these statutory resident definitions matter is that it means showing domicile in a particular state isn’t enough to ensure that only that particular state will tax the household. Instead, domicile merely ensures that state is a state of residence, but other states may claim the individual is a (statutory) resident as well, triggering another potential layer of income taxes in the second state (potentially on top of the first). Furthermore, in a world where different states use different definitions of statutory residency, it becomes possible to have two different states both claim someone is a resident in their state under the statutory resident rules as well, if they use different (shorter) time periods to determine statutory residency status.
Why Does Domicile Matter?
The importance of an individual’s domicile cannot be overstated. It impacts everything from income taxes, to creditor protection (and which state’s asset protection rules can be relied upon), to matters of family law (such as guardianship over children and the rights of a spouse in a divorce).
The State Of Domicile (Generally) Taxes All Worldwide Income
The most significant impact of “domicile” for many individuals is the potential impact of state income taxes. Notably, as discussed above, an individual is essentially a default resident of the state in which they have their domicile for tax purposes. And generally speaking, all of the worldwide income earned by an individual is taxable to the state in which they are a resident, regardless of where that income is actually earned or generated.
For example, an individual who is domiciled in California is working temporarily in Iowa, owns rental property generating taxable income in Massachusetts, and is a limited partner in an investment in Florida. All of the income from all of these sources will be subject to California state income tax, because California is the state of domicile…even if the individual spends not a single day in California during the entire year!
That, in a nutshell, is the power of domicile. Without California being the state of domicile, without earning any income in California, and without spending any time in California, California would have not be entitled to a single dollar of income tax!
Of course, that’s not to say California will be the only state wetting its tax beak in the situation described above. Iowa can tax the earnings generated in Iowa, and Massachusetts will be able to tax the rental income generated there. (Florida has no state income tax, so nothing to “worry” about there.) Even though all of that income is also subject to California state income tax. Fortunately, California, like most states, will provide a credit for taxes paid to other states (for the lesser of the amount of tax paid, or the amount of tax that would normally be paid on that income in California). However, since California’s income tax rates are higher, the difference between the taxes paid to Iowa and Massachusetts, and the full amount of tax owed on the same income to California, will still be owed to California.
Notably, while states offer a credit for taxes paid to other states, the end result is generally that where income is subject to tax in two or more states, the household ends up paying total state taxes at the higher of the two state income tax rates, one way or another. Consider the following simplified example to illustrate this point:
Example: Charles is domiciled in State “A”, which imposes a 7% tax on all of his income. During the year, however, Charles is called away on temporary assignment to state “B”, and as a result, doesn’t earn any income in State A, but does earn $50,000 in State B. Accordingly, state B taxes his income at 6%. Finally, Charles is the owner of a condo in state “C”, which generate $10,000 of taxable income. The state income tax rate for state C is 8%.
Given the facts outlined above, here’s how Charles would generally be taxed by states A, B, and C on his income:
- Charles’ $50,000 of employment income would be taxed by State B at its 6% income tax rate because it was earned in state B. Thus, Charles would owe $3,000 of state income tax to state B. Additionally, state A – Charles’s state of domicile – would impose its 7% state income tax on the same $50,000, resulting in a tax bill of $3,500. However, state A will give Charles a credit of that $3,000 – the amount paid to state B – towards its own tax bill of $3,500. Thus, Charles will owe $500 of additional tax on the same income to state A. Which means in the end, Charles has paid a total of $3,500 of combined state income tax on this income… which is equal to the $50,000 of income he earned times the (higher) 7% tax rate of his domiciled state. The state tax credit rules simply facilitate splitting the bill between two states, where state B gets “first crack” at taxing the income because it was earned there.
- Charles’ $10,000 of condo rental income would be taxed by state C at its 8% income tax rate. Thus, Charles would owe $800 of state income tax to state C. Additionally, state A – Charles’s state of domicile – would impose its 7% state income tax on the same $10,000, resulting in a pre-credit tax bill of $700. Since Charles earned the $10,000 in state C, then again state C gets “first crack” at taxing that income. Here, state A will give Charles a state tax credit of up to $800, though Charles can only use $700 of it (the amount that his home state A would have taxed that income in the first place, and enough to completely offset his state A tax liability). Notably, the end result is that Charles has paid a total of $800 of cumulative state income tax, which once again is equal to the income produced ($10,000) times the higher of the two state income tax rates.
Again, the key point is that income across multiple states is often taxed in multiple states – once in the state where it was earned, and again in the earner’s state of domicile. But while each state can only tax the portion of income that’s actually connected to that state, domicile is crucial to determine because the state of domicile has the right to tax all of that individual’s income (whether it was earned in that state or not).
Accordingly, those who may have domicile in a high-tax-rate state must be cautious, as all income from other states will still be pulled into that state’s higher tax rate. While those who live in the handful of states imposing no state income tax at all won’t have to worry about any domicile-related state income taxes (though again, income earned in other states may still be subject to the other state’s income tax rate). More generally, this means that with a wide range of states from a tax rate of 0% up to a few states with income tax rates reaching into the double-digits, choice of domicile can have a marked impact on personal finances (to say nothing of differences in cost-of-living)!
And in limited circumstances, an individual’s state of domicile can also impact Federal income taxes as well. For example, there is currently a $250,000 ($500,000 for married couples) potential exclusion of gain on the sale of a primary residence. That primary residence must, by definition, be an individual’s domicile (or else it can’t be their primary residence).
Real Estate Benefits Are Often Available Only For A Primary Residence (In Your State Of Domicile)
Although there is a substantial amount of variability from state to state, many states provide real estate benefits to persons domiciled within their state. These benefits can a number of different forms.
For example, many states offer some sort of property tax break to individuals on their primary residence. Oftentimes, this benefit comes in the form of a reduction to the assessed value of an individual’s home which, in turn, lowers the homeowner’s property tax bill. Other states cap increases on property taxes to a limited percentage per year. But these benefits only apply to the primary residence and aren’t available for those who simply own non-resident investment real estate in the state.
Another common benefit states may provide to individuals domiciled within the state who are property owners is a Homestead Exemption. Homestead Exemption laws vary by state – and not all states have one – but where they do exist, they generally provide some level of creditor protection for a person’s primary residence. In some states, such as Florida, Texas, and South Dakota, a Homestead Exemption can shield an unlimited amount of a primary residence’s value from most creditors. In other states, such as Nevada ($550,000) and Montana ($250,000), the Homestead Exemption can protect only a limited amount of a home’s value from the reach of creditors. Still, though, individuals who are not domiciled in those states receive no creditor protection for their individually-owned real estate holdings.
Strategies, Tactics, And Tips To Establish A New Domicile
When changing domiciles, it’s impossible to leave one’s old domicile until he/she has established and arrived in their new domicile. This is sometimes referred to as the “leave and land” rule.
Notably, this necessitates having a residence which can reasonably be viewed as an individual’s fixed home. And from there, the key is taking enough of the right steps to establish one’s intent to make that home a permanent “base of operation.” Common steps to take show such intent include spending as much time as possible in the new state of domicile, changing the address on as many accounts, bills, etc. as possible to the new residence, and taking steps to integrate oneself as much as possible into their new community (i.e., joining clubs, organizations and houses of worship).
Of all the steps that an individual can take to show intent of a change of domicile, time spent in a state is still one of the most, if not the most, important elements in the process (though not solely determinative). Thus, for individual’s who wish to demonstrate they have made a bona fide change of domicile, keeping track of time spent in the state of domicile is critically important.
Personal and business calendars can be helpful and may even be introduced as evidence (if domicile is ever challenged), but such items are often given only modest weight since they are produced by the taxpayer themselves in the first place (and can potentially be altered by the taxpayer to serve their own goals as well). Thus, additional records, such as credit card receipts and statements showing dates of purchases of items within the “new” domicile state, EZ Pass or other freeway charges, flight records, landline telephone records, and cell phone records with GPS time/date stamps call all help bolster an individual’s claims that they’ve “really” changed to the new domicile.
Real estate ownership and properties rented can also be strong indicators of a person’s intent. Generally, if an individual owns one residence and rents another, more weight will be given to the owned home. However, additional factors may also be considered, such as the way the residences are furnished. Remember, an individual’s domicile is the place they intend to be their permanent home. Naturally, the nicer a home is furnished, and the more suitable it is for year-round use, the more likely it will be considered a person’s principal residence.
In a similar vein, most people want to be close to the things they value the most (no surprise there). So with that in mind, another key element in determining whether an individual has truly changed domiciles is, “What have they done with the stuff they value most? Where are the items that are “near and dear?”
Do you have valuable artwork or jewelry? Consider moving as many of those items as possible to your new domicile. Do you have a safety deposit box? Move that too! More than one car? Make sure that your nicest one(s) is/are at the home you intend to make your domicile.
Even pets… yes, pets(!)… can play a role. Talk to many pet owners and they’ll tell you that their pet is a “member of the family.” Indeed, In the Matter of the Petition of Gregory Blatt, decided by the State of New York Division of Tax Appeals on February 2, 2017, Blatt’s dog ended up saving him more than $400,000 in New York State income taxes. While Blatt had previously undertaken many of the steps necessary to change domiciles, the New York State Administrative Law Judge hearing the case on appeal determined that his change of domicile was effectively completed when he moved his dog.
“As demonstrated by a contemporaneous email regarding his move, petitioner stated that his change in domicile to Dallas was complete once his dog was moved there.”
Proving Intent Regarding A Change In Domicile To A New State
Usually, there is no single fact or detail to “prove” intent. Rather, intent is “proven” through a cumulative review of an individual’s actions over time.
With that in mind, taking the following steps/actions in the state in which one hopes to make their new domicile can be helpful:
- Registering to vote (with “bonus points” for actually taking the effort to vote there)
- Registering an automobile
- Registering other property, such as motorcycles and boats
- Filing taxes as a “Resident”
- Changing car insurance to cover the car in that state
- Switching gym memberships
- Signing up for local newspapers
- Updating an estate plan (with regard to changing the situs of trusts, the state in which a will is signed, etc.)
- Filing a “Declaration of Domicile” or similar document if the state has such a procedure
- Using doctors, lawyers, dentists, accountants, hairdressers, social workers, and other professionals
- Purchasing a cemetery plot
- Forwarding mail from other locations to the intended domicile
- Purchasing local television and internet connections
- Gathering for family holidays and other events
- Seeking some level of employment
- Joining a new house of worship
It’s important to remember that while states generally agree on the definition on domicile, they don’t all agree on what factors should be used in determining domicile, or what weight certain factors should be given. Thus, when trying to establish a new domicile – and more importantly, sever an old one – it’s important to review and understand both states’ specific rules. Especially if the change in domicile is not a clean break.
Strategies, Tactics, And Tips To Sever An Old New Domicile
Just as establishing as many ties as possible to the new state can be helpful when a change of domicile is desired, it’s also helpful to try and sever ties to the old domicile. Indeed, when domicile challenges arise, they almost always revolve around the old state not willing to give up its status as “domicile,” rather than an issue of the new state refusing to accept that status.
If possible, for the cleanest of breaks with a change in domicile, it’s best to sell any and all real estate owned in the old domicile state. This, coupled with the purchase of a new residence in another state, is probably the single best indicator of a person’s intent to change domicile, and is why most people – who can’t afford to own two homes anyway – have little trouble establishing a change of domicile when they really do sell their old home in their old state and move entirely to a new home in a new state.
Of course for a variety of reasons, an individual may wish to retain at least some residence in their (hopefully) former state of domicile. In such cases, and even if no residence is maintained, it’s also helpful to try and spend as little time as possible in the old state of domicile… at least for the first few years. As returning to the old/prior state and spending a substantial amount of time with family and friends – even if you stay in their homes as a guest – can complicate matters and raise the question of whether the individual really left.
And just as opening accounts and memberships in your new domicile can be effective, so too can canceling/closing local bank and other accounts, gym memberships, associations memberships, etc., in your old domicile state. Turn in your driver’s license as soon as possible as well, and if there’s still any income in the old domicile state, be sure to file tax returns as a non-resident whenever possible.
Remember, the more you can distance yourself from your ex, the better off you’re going to be! Especially if there’s a new state in your life!
Avoid The January 1st Trap When Changing State Of Domicile
One easy way to make a former state suspicious of an individual’s change of domicile is to indicate that the change in domicile took place on January 1st of the year of the change when filing state tax returns. And yet, this is often the date CPAs and other tax preparers will choose to use to indicate the change in domicile.
Why? Because it makes things “easy” (at least, for income tax purposes)!
Making the change on January 1st, for instance, means no partial-year resident and non-resident returns, which cuts down on the amount of expenses and income that need to be allocated between different states, and simply the number of different partial-year returns being filed. The problem, though, is that virtually nobody actually moves on January 1st.
Sure, it’s theoretically possible that you boxed up everything on New Year’s Eve, watched the ball drop from a motel on the way, and moved into your new home in your new state of domicile on New Year’s Day, but in practice, it just doesn’t happen! And so by putting a January 1st date on your tax return for when you became a resident of your new state (by virtue of a change in domicile), you’re potentially creating two problems.
First, you’re raising a red flag for residency auditors because – guess what? – they know people don’t move on January 1st either!
The other issue the January 1st date creates is a lack of trust between you and an auditor, should it come to it. Think about it… when you file your return, you’re certifying that information by penalty of law!
So what do you do when the auditor asks you about the January 1st date you both know is a bunch of “BS”? Tell them, “Well Mr./Ms. auditor, we were just using the January 1st date even though it wasn’t entirely true because it was easy and saved us time and money. But we swear, we’re telling the truth about everything else though!”
Needless to say, by that point you’ve likely seriously damaged your chances of a successful outcome with a residency auditor. Thankfully, the “solution” to this problem is easy. Don’t take the easy way out! Report the actual date you arrive at the new domicile properly on your return – even if it requires partial-year resident and non-resident returns in the old and/or new states – and avoid this red flag.
Today’s society is more mobile than ever before. But while individuals may be quick to change locations, sometimes the states they leave behind are not as quick to let them go.
In part due to the financial difficulties many states face today, the number of states pursuing residency audits has spiked, especially higher-tax-rate states that have a higher likelihood of their residents incorrectly trying to change domicile just to avoid those high state income taxes. Thus, states like New York, California, Connecticut, and Massachusetts have long been known to have some of the most aggressive residency audit programs in the country, but today, are being joined in that “game” by states like North Carolina and Idaho as well.
Individuals – particularly those in northern states who travel to the south during the winter months – are often surprised by the complexity of the domicile rules. All too commonly, they falsely believe that a 184+ day “stint” in the south gets them both warm weather and a lower tax bill. That’s often not the case.
Unfortunately, there’s no single bright-line test that can be used to “prove” a change in domicile, because it’s based on a determination of “intent” that simply isn’t always clear. But the good news is that there is a long list of “dos” and “don’ts” that individuals can follow to help give themselves the best opportunity at proving a bona fide change that can result in lower income taxes, lower real estate taxes, enhanced creditor protection, and other valuable benefits.