Retirement

Beware The Tax Traps Sprung On Those Who Move In Retirement

The migration from high-tax states to lower-tax states that accelerated during the pandemic continues today.

To fight the tax loss from the population shift, a number of high-tax states aggressively seek to identify people who moved out of their borders and continue imposing income and estate taxes on them.

The states generally impose income, estate, and sales taxes based on your residence or domicile, and your status under the law isn’t as simple as many people expect.

That’s why aggressive high-tax states claim that people who think they’ve moved to another state haven’t changed their residence or domicile for tax purposes, potentially leaving people exposed to taxes in two states.

Tax departments of high-tax states regularly begin with a residency audit. Tax and estate planners say they’ve seen an increase in residency audits in recent years.

When a state sees that someone who used to file an income tax return as a full-time resident now files as a part-time resident or doesn’t file at all, the state takes a close look. A residency audit might consist of sending the person a questionnaire asking about their residence, lifestyle, and property owned.

Aggressive states also search property records and other public records for evidence of continuing contacts with the state. Some have been known to review social media sites.

To avoid having two states claim you owe them taxes, especially if you’re an upper-middle class taxpayer, when moving you need to plan how to prove that you legally established residence or domicile in the new state.

It’s best to prepare for a residency audit early, even before starting the move when possible.

If you receive a letter from a state tax authority raising questions about your residence status, you should assume the state already conducted a lot of research. The letter might be accompanied by a questionnaire or a request for an interview, or both.

Plan your move and accumulate your documentation with a potential residency audit in mind. Don’t go into a residency audit unprepared or without professional help.

Your defense is to show that you severed all or most ties with the old state and made major changes in your lifestyle, centering your life around the new state.

First, learn the old state’s rule for taxing people.

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. Spend fewer than 183 days in the state and you’ll be taxed only on income earned while working in the state or property owned in the state.

Be careful about getting close to the 183-day threshold. States have different rules for travel days and other days when you’re in the state only part of the day. You might be considered present in a state for a full day when you were there only a few hours.

If you travel back to your old state from time to time or maintain property there, you should maintain logs or calendars that list where you were each day of the year. Also, keep receipts and other records that back up what’s in the logs or calendars.

Be aware of how technology tracks you. The aggressive states might review cell phone records and other technology trails.

Instead of the 183-day rule, other states impose taxes based on a person’s domicile. A domicile is the place a person intended to maintain a permanent residence or abode indefinitely. It’s a subjective test in which the state looks at the facts and circumstances to determine your intention.

The domicile 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 still be considered domiciled there when other facts indicate you didn’t intend to leave permanently.

The key to showing you changed domicile is to reduce or eliminate contacts with the old state.

Continuing to own a home or business in the old state is considered a significant contact and can override other facts. Sometimes it’s acceptable to downsize and maintain a smaller home in the old state, but it’s risky. The safest route is to not 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.

As much as you can, sever all other contacts with the old state. The more contacts you maintain, the greater the likelihood that you’ll be viewed as a domicile.

Your driver’s license, auto registrations, voter registration and church and club memberships all should be changed.

Many states won’t consider the move permanent if memberships are switched to inactive, nonresident, or associate status instead of being resigned or transferred. They’ll argue the change is temporary and you easily can switch back to full or resident membership.

Some states also 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 leaving valuable items, even in storage, is 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.

Another bad ploy: Tell an insurance company you are resident in one state because premiums are lower for its residents, but tell the state you are resident elsewhere.

In other words, be sure all your actions are consistent with each other and with the idea that you made a permanent move.

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 states can swoop in and assert their claims against your estate.

States might not be your only concern. Cities and counties with income taxes use the same tactics to retain tax dollars.

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