Tax Residency Is Not as Clear as You Would Think
With the upcoming “Millionaire’s Tax” ballot initiative in Massachusetts (“MA”) proposing to tax people earning over a $1,000,000 an extra 4%, and the fact that Massachusetts is one of only 17 states to have an estate or inheritance tax, some residents who have second homes in states with lower or no state income tax are considering whether they should change their tax residency to another state. It would seem like a sensible plan to use your Florida condominium as your taxable residence. However, changing tax residency is far from simple. We will use leaving Massachusetts as a tax payer as a sample case in this article, but understand that each state has its own set of regulations.
Statutory Resident
There are two tests – statutory resident or domicile – that determine your tax residency. If you meet either test, you are considered a Massachusetts taxpayer.
A statutory resident is anyone who spends more than 183 days or partial days of a taxable year in Massachusetts AND maintains a home in the state. Partial days include departing, arriving or passing through and the Department of Revenue (“DOR”) has no exceptions for funerals, emergencies or even involuntary hospitalizations. The taxpayer must keep exacting records of their whereabouts, using a spreadsheet, personal calendar or a web-based tracking app. Some of the more popular tracking apps include, Domicile 365, TaxBird, TaxDay and Moneo. In addition to looking at taxpayer records, the DOR will examine credit/debit card records of purchases and E-Z Pass driving records to confirm where a taxpayer has been.
A taxpayer also must have a “permanent place of abode” in the state. A taxpayer ceases to be a statutory resident the moment they no longer maintain a home in the state by selling a MA home or terminating a MA lease. However, don’t forget, you still can be deemed a MA taxpayer under the domicile test discussed below.
Domicile
Even if you meet the exacting requirements to claim statutory residence outside of MA, you can still be considered a MA taxpayer if you fail to properly establish your domicile outside of the state. This is a tricky test because it is not defined by law, but rather by court decisions. A person can have multiple residences, but only one domicile. You are considered to be domiciled where you reside with intent to stay permanently and no intent to return to your previous state. In addition, your domicile is the center of your domestic, social and civic life, i.e., where your “heart and home” resides. This is a subjective definition and Massachusetts has put the burden of proof on taxpayers to establish that their domicile has changed.
There are many factors which influence a judgement by the DOR on your state of domicile. The first one is where you are physically, supported by carefully documented records. Another factor is where you spend your holidays. If you have two homes, one in Boston and one in Florida, where does your family gather for holidays? It is a good fact pattern for you to host holidays in the state in which you wish to be domiciled. Additionally, the items which are “near and dear” to you, such as photo albums, family heirlooms, and pets, should be moved to your place of domicile at the time you are making the change.
Family, social and business connections should be strong in your new place of domicile. Bank accounts, mailing address, voter registration, driver’s license, car registration and property, automobile and health insurance policies all need to be changed. Rewrite your estate planning documents and get new professional services (doctors, dentists, accountants). Join a social club, place of worship, and/or a professional organization. There is a checklist on the DOR website of items to consider when changing your tax residency (click here).
Massachusetts State Income Tax
Massachusetts taxes two types of income - earned (salaries, wages, tips and commissions) and unearned (interest, dividends and capital gains). It does not tax Social Security income. Notably, income earned or created while being a Massachusetts taxpayer (“source income”) can be claimed by MA even after you have moved out of state. This would occur in situations such as deferred compensation, stock options, investments in MA-based partnerships which pass through income, and proceeds from the sale of business interests located in MA. Even if you think you are out of MA tax jurisdiction, you may have income within their reach.
Part-Year Residents
A part-year resident is someone who moves mid-year (either in or out of state). They are generally only taxed on MA source income on the part of the year when they are a nonresident. However, if they are also a statutory resident (owning or leasing property in MA), they are taxed as a resident for the full year. Normally, your state of residence offers credit to the tax you pay to another state as a nonresident. This becomes stickier if your new state of tax residence is a low- or no-income state as you have nothing to credit that tax against.
Split Domicile
It is possible for married spouses who split their time between two residences to have separate domiciles based on the fact patterns listed above. In instances of this “split domicile”, the married spouses will file separate tax returns under the married filing separately (“MFS”) tax status. While it is possible to have split domicile, the benefits of paying less state income tax must be weighed against the higher federal tax rate in the MFS category.
Careful Planning is Essential
Massachusetts is known to be quite aggressive in fighting residency changes, particularly when there is significant wealth involved. There is a greater chance that you will be audited if leaving Massachusetts for a lower tax state such as Florida. A domicile audit can be very intrusive and expensive so it pays to enlist professional legal and tax assistance prior to a change.
The key to establishing your new domicile is to carefully craft your story of intent. Don’t do this haphazardly, but attempt to arrange your change in conjunction with something else major going on in your life, such as retiring from your job, a change in health status, changing family situation such as marriage, divorce or death, or the sale of your family home in Massachusetts.
Making a tax domicile change just prior to a large tax gain recognition event (such as selling a business) is allowed but will attract extra scrutiny. Be prepared in advance with laying the groundwork for your domicile change.
Estate Tax Considerations
Massachusetts imposes an estate tax on assets above $1,000,000 on a graduated basis between 3.65% and 16%. The $1,000,000 also includes assets located outside the state of Massachusetts. If you change your tax residency for income tax purposes, your tax residency will be changed for estate tax purposes. It is essential to update your estate planning documents to reflect state laws for your new state.
Conclusion
As you can see by this discussion, changing your residency for tax purposes is a complicated process which requires careful planning to avoid a time-consuming tax audit. While it may significantly benefit you from a financial standpoint, the time and money spent in planning for a successful transition cannot be overlooked. It is much easier to establish a domicile than it is to terminate an existing one, but there are professionals out there that can help ensure a successful transition.
IRS Disclosure
Neither Sandy Cove Advisors, LLC nor its employees provide tax or legal advice. Accordingly, please be advised that any discussion of U.S. tax matters contained within this communication is not intended or written to be used and cannot be used for the purpose of (i) avoiding U.S. tax related penalties or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.