Establishing a Change of Domicile for State Income Tax Purposes
For individuals who are moving from one state to another or for residents with homes in multiple states, legally establishing “domicile” can get a bit tricky. The state in which an individual resides may not always be their place of domicile, especially as it is seen in the eyes of the law.
While the terms “residence” and “domicile” may be used interchangeably in everyday speech, they are in fact, not synonymous when it comes to legal matters such as state income tax or laws governing the protection of your assets.
A “residence” is simply a place where an individual lives. One can have multiple residences, but for legal purposes, only one domicile.
Essentially, the concept of a domicile dictates the legal relationship between an individual and a locality. While the exact definition of domicile may very slightly from state to state, the common concepts are: permanency and intent. The domicile is an individual’s permanent legal residence where they intend to make a permanent home.
The intention is the operative part of the definition, especially for folks with multiple residences who spend a significant amount of time in each throughout the year. You may think, “Oh, that’s easy, between my two residences in New Hampshire and Florida, I spent 10 more days a year in Florida. That must be my domicile.” However, this is not always the case because of “intent.”
If an individual spends more time in Florida, but never demonstrates intent to make Florida their permanent residence (by getting a Florida license or registering their vehicles in Florida, for example), a third party could deem these actions substantial enough to nullify the claim to Florida domicile.
Impact of Domicile on State Income Tax
Why does it matter? Where you hold domicile will affect everything from your income taxes to which state’s laws will apply to the protection of your assets (from creditors) to family law matters, such as divorce and guardianship.
Financially, though, for most individuals, the greatest impact of domicile will be on state income taxes.
State income taxes are assessed on all your worldwide income. That is, all of your income, despite where you earned it, will be taxable in the state you establish domicile. If you live in New Mexico, for example, the rental income from your condo in Vermont, the income you earned from temporarily working in Texas, and any revenue from your business in Seattle will all be subject to New Mexico’s state income tax. Even if you don’t earn a dime of income in New Mexico or spend the entire year outside the state traveling for work, all your income will still be subject to their state income taxes.
You can see, then, why it is not uncommon for individuals to purchase a temporary residence in a low or no income tax state in an attempt to lower their tax bill. And as a result of such attempts, actually establishing domicile in one of these states could potentially involve jumping through quite a few legal hoops.
Costly Risks in Not Establishing Domicile
Many individuals are unaware of the substantial costs associated with not successfully establishing domicile:
If you move or reside in multiple states, but don’t established domicile anywhere,
(1) Each state in which you reside could veritably claim you are their domiciliary and all attempt to assess state income tax on your worldwide income.
(2) Each state could attempt to make claims for state death taxes (resulting in costly legal complications for your family to sort it all out after your death).
Or, if you move to a state with a lower or nonexistent state income tax, but don’t legally establish domicile there,
(3) You may still be liable for the state income tax rate (or investment income taxes if in New Hampshire and Tennessee) of the previous state. And States without income taxes, like Florida and Nevada, will be stringent in verifying your domicile to ensure temporary residences aren’t attempting to use the state an income tax shelter while spending the majority of your time elsewhere.
Keep in mind, also, that unless an individual files to legally amend their state of domicile and provide appropriate evidence of such, the general presumption is that no such move has occurred. So whether you are planning to move or are maintaining multiple residences across the country, you’ll want to take the necessary steps to establish your domicile where appropriate in order to avoid paying unnecessary taxes and fees.
At Northstar Financial Planning, we know how damaging the improper tax setup can be and aim to help our clients limit their liabilities as much as possible. If you foresee a move to another state in your future, or if own multiple residences in different states and are unsure if you’re taking advantage of the best state income tax opportunity available to you, please feel free to contact us today. One of our Certified Financial Planner® professionals would be happy to take a look at your current situation and discuss your possibilities with you.