In January 1996 Robert Amen, president of International Paper moved from Stamford, Connecticut to Belgium as head of International Paper’s European operations. His wife and daughter followed that April, while his youngest son stayed behind in New Canaan Connecticut to finish high school. Relying on their company-paid accountants, the Amens filed their 1996 Connecticut state income tax returns as part-year residents. But in April a judge ruled they had never legally changed their domicile and owed Connecticut tax on all their 1996 income.
Some of the evidence against them:
They had leased out their Connecticut home instead of selling it; they had switched their country club membership to inactive instead of resigning; and Mrs. Amen’s mother lived in Connecticut.
If you’re planning to move or if you have homes in more than one state, watch out. States are getting ever more creative about collecting income tax from people who have any ties to their territory. Even states without income taxes are getting into the act, with sales- and use-tax audits.
Upping the stakes in the residency wars: Many states’ estate taxes, invisible and painless until a 2001 change in federal law, have since become real burdens because the federal estate tax credit that used to be available to offset -them is now gone.
What makes residency particularly tricky is that each state has its own set of rules. Some simply count the days you’ve spent there. Spend at least 183 days in Michigan in a year and you’re a resident for tax purposes—although not necessarily for the purposes of getting cheaper in- state tuition at the University of Michigan. Other states look at days, but also try to determine where you intend to make your permanent home. Connecticut divines intent from 28 factors ranging from where you register your dog to where you pray.
The result is that you could end up paying tax on the same income to two states. How about the lucky man who sold stock and found California, Connecticut and New York all wanted a cut of his profit! The man has homes in all three states and arguably meets all three states’ residency tests. His wife, kids and roots are in Connecticut. But he spent more than 183 days in New York and was assigned to work indefinitely on a project in California. Like a normal commuter working in New York and living in Connecticut, he could claim a Connecticut tax credit for the New York taxes he paid on his wages during the days he actually worked in New York. But Connecticut wouldn’t cut him a break for the New York or California taxes on his capital gains!
Even if you don’t end up paying double tax, residency audits can be brutal. Your credit card charges, telephone calls and where you keep your underwear could all be scrutinized and might become a matter of public record! Inventor Gilbert Hyatt claims a California auditor went through his trash and spread inaccurate information about him as the auditor sought to prove he owed taxes on $40 million in patent licensing fees. Hyatt insists he moved to Nevada (which has no income tax) before getting the fees and is suing California in a Nevada court for invasion of privacy. Last year the U.S. Supreme Court ruled that Hyatt could proceed with his privacy suit in Nevada. (The outcome could impact the nosiness of tax auditors nationwide.) Meanwhile his tax case in California is on hold.
Here’s how to leave a state—and its taxes—behind:
1. Put down new roots. Just moving out of your old state is not enough; you need to show you’ve cut your old roots and planted new ones elsewhere. It used to be you could just change your driver’s license and register to vote in your new state and “bam”, you had a new domicile. Now State tax collectors take the position that anyone can fill out a piece of paper and that’s not enough to show a change of residency; you have to change your lifestyle to show that you have changed your residency so that you can overcome the burden of proving residency.
After graduating from the University of Alabama in 2002, Tara Kolstad took a job on a cruise line operating out of Seattle. She sublet her Birmingham apartment, gave her car to her brother and bought a one-way ticket to Seattle. In July, however, an Alabama administrative law judge ruled that Kolstad hadn’t permanently moved to Seattle and so was still legally domiciled in Alabama in 2003 and owed it tax. The Court noted she hadn’t rented an apartment in Seattle for the cruise’s off-seasons she testified she couldn’t afford one and instead stayed with friends in Alabama, Arizona, Tennessee and China. At least the judge acknowledged the case was a “close call” and erased penalties.
A Minnesota Tax Court judge was harsher on retired physician Roger Dreyling, who filed as a nonresident, claiming he was domiciled in state- income-tax-free Alaska. After retiring, he lived part-time in Alaska, fishing, hunting and working briefly as a tribal doctor. He got an Alaska medical license but didn’t give up his Minnesota license. He registered to vote in Alaska but didn’t vote.
The judge concluded in February that Dreyling merely “went through the motions of trying to establish a domicile in Alaska to avoid his Minnesota tax liability” and that the center of his family, business and social life remained in Minnesota. The judge upheld a 50% fraud penalty and a 20% underpayment penalty because, he said, Dreyling had refused to hand over banking records and hadn’t consulted a tax pro on the residency issue. Dreyling, who says he did consult his CPA, has appealed to the Minnesota Supreme Court.
2. Be consistent. That means don’t double dip. Physician Dreyling, for example, continued to claim the “homestead” property tax break on the Minnesota house where his wife remained. And while he got an Alaska driver’s license, he kept his “surrendered” Minnesota license and used it to get cheaper resident fishing and hunting licenses there.
Another inconsistency: A business owner hands over control to his kids or partners and moves out of state. But on his federal return he continues to treat the business as if he’s an active—not a passive—investor in it. (There’s a benefit to that since losses and credits from passive activities can’t be deducted against non- passive income such as interest or dividends.) No, you don’t have to give up all your business ties in your old state, but it’s a tricky issue and you need professional advice. One man who told auditors he was “deeply, deeply involved” in the operation of a New York business and felt that his involvement was “vital to the health of the company” had to pay for it as a New York resident -
3. Live large in your new domicile, Auditors will compare your asserted new domicile to your other home or homes. If you trade in your five-bedroom New York house for a four-bedroom house in Florida and a New York City studio, that’s a better case for Florida residency than if you keep your five-bedroom house in New York and rent a small condo in Florida.
If you want to keep a home in your old state, consider selling your old property and buying a new, smaller place. True, there are transaction costs. But remember, if you want to claim the $500,000 per-couple federal capital gains exclusion on the sale of your old home, you’d have to sell soon anyway. To qualify for the break, the property must have been claimed as your primary residence for at least two of the five years before the sale.
Make sure your new home fits your circumstances. After separating from his wife, New York tax adviser Craig Knight moved out of their New Jersey house and claimed his childhood bedroom in his parents’ New Jersey home as his domicile. New York auditors didn’t buy it. They decided he lived at a New York corporate apartment near his office, where he received personal bank statements. In June a New York Division of Tax Appeals administrative law judge upheld the auditors; Knight is now appealing a $550,000 back tax bill.
Even if you keep your big old place, move your valuables—your art, your jewelry and the insurance on them to your new home. These days New York even expects you to take your fur coat down to Florida! Earlier New York audit guidelines allowed you to keep a fur up north without counting it as evidence that New York was still your real home. Anthony Ittleson moved to South Carolina in 1996 but left his artwork in his co-op apartment that he had lived in since 1986 intending to move the artwork when the apartment was sold. When he sold the painting after moving to South Carolina the New York tax appeals tribunal ruled that the artwork was New York property and subject to 6.85% tax on the 7 million dollar gain on the sale of the artwork! The argument that the artwork was only in New York for temporary storage did not work, the artwork should have followed him to South Carolina and then sent back for auction.
4. Count your days! Most states presume you’ll spend more time at home than any other place. Suppose you spend 170 days in New York, less than the 183 days that would automatically make you a New York resident, but if you spent only 90 days in Florida, your intended residence and the rest of the year traveling, New York won’t necessarily concede that you live in Florida. If you need to connect to an international flight through JFK, don t leave the terminal for lunch, or New York will count it as a day in New York.
SALES TAX TRAP: If you live in one state and buy expensive personal property in another you could face a sales and use-tax audit. Sales taxes are supposed to be levied by the state in which property is used. Boats bought in Florida by nonresidents are exempt from the state’s 6% sales tax provided they leave Florida within 90 days of purchase and don’t return within six months of purchase. Florida does permit an exception: A boat can dock at a registered repair facility for up to 20 days in any calendar year without being counted as in-state property.