How Much Can You Save by Moving to a Low-Tax State?

Think you've escaped a huge tax bill by heading to a tax-free state or another country? It all depends what your old state considers your domicile.

Just jumping to Florida, Nevada, Washington or some other country won't provide you any tax savings if a state can prove that you still have a whole lot of vested interest in your old home. If you're still spending a lot of time in state or still have ties to churches or organizations or even have precious belongings in that state, that state can make a case for taking a bigger chunk of your tax dollars. Laurie Samay, an associate with Palisades Hudson Financial Group’s Scarsdale, N.Y., office says it isn't all that uncommon.

“It’s a trend,” she says. “Given the tax revenue at stake, establishing a change in domicile can be a highly contentious issue, especially for individuals with large amounts of out-of-state income in play. New York in particular has carved out a reputation for aggressively working to prove that taxpayers are domiciled in the state, even when such claims defy common sense.”

While the law shields U.S. military members from this to a degree, several states are trying to extract cash on taxpayers who claim they’re no longer domiciled there after moving away. Samay points to a couple who moved to London when one spouse became an attaché at the U.S. Embassy, but still had to pay Georgia income taxes after a court ruled against them last December.

“I think domicile, in general, is about intent,” says Tom Corrie, principal at New York-based Friedman LLP and director of the firm's state and local tax group. “Your domicile is the place that you intend to be your permanent home and, by its very nature, intent is somewhat subjective. You have to establish, through objective criteria, that you have this intent to make this place your permanent home.”

Corrie notes that a change of domicile typically occurs around a major life event such as marriage, divorce or retirement. However, simply because those events have occurred and you've finally found some property in the tax-free state of your dreams doesn't mean that you've changed domiciles. You've just changed residences, as many retirees who aren't quite ready to cut ties back home discover.

“If they're retiring to Florida, which is a non-income tax state, and trying to say they aren't domiciled in New York, the problem is when they maintain a home in New York,” Corrie says. “If I'm in New York and have a home worth $2 million and I have a $200,000 condo down in Florida and I'm maintaining that I don't have a connection to New York, that's not a good supporting argument.”

New York and other states have a whole lot of motivation to enforce domicile laws. States with a personal income tax generally tax residents on their worldwide income. By contrast, nonresidents are taxed only on in-state income, such as wages earned in the state or gains on the sale of in-state real property. If you are or ever have been a resident, there's a lot more to go after.

Corrie notes that New York looks at five primary factors when determining domicile: 1. Do you have a home in New York? 2. How much time do you spend in state? 3. Do you have business connections in state? 4. Where are your valuable items (high-value paintings, wedding photos) located? 5. Do you have family connections (especially a spouse and minor children) in state? When those can't determine domicile, the state looks at secondary criteria including where you're registered to vote and where you hold various licenses.

“If you have a man who lives in New York and moves out to Nevada to take a position, but leaves his wife and ten- and five-year-old children in New York, it's going to be very difficult for him to take a position that he's now domiciled in Nevada and doesn't have to pay income taxes, because New York will apply these five criteria,” Corrie says.

Samay notes that the definition of domicile varies from state to state. Some states define domicile by statute, with New York mandating that anyone with a permanent abode in New York who spends more than 180 days there is officially domiciled in New York. Basically, if you're an executive who keeps and apartment in New York but lives in Greenwich, Conn., you'd best find a way to spend 186 full days outside of the city. However, other states base their definition of domicile on court cases and precedent and won't consider your domicile to be elsewhere until you've abandoned it and established a new one in another state or country.

That requires documentation and lots of it. In the Georgia case, for instance, the court noted that the couple didn’t pay U.K. income taxes, which, among other factors, suggested their intention to eventually return to Georgia.

“Given this ambiguity, it is wise to offer as much evidence as possible when making or defending a domicile claim,” Samay says.

Along with the five primary factors and multiple secondary New York State considers when establishing domicile, it also helps to have a pile of paperwork to fall back on. Corrie recommends keeping contemporaneous records of where you are and what you're doing. Those could include a daily journal, EZ-Pass records (or toll receipts), ATM records, travel records (plane and train tickets) and mobile phone records. He advises keeping such records for three years, not including the current year, to avoid running afoul of a state's statute of limitations in the event of an audit.

“You have to prove your location and it's not incumbent on the state auditors to prove you were in the state,” Corrie says. “All of these things are important and you don't want to have to go back and recreate the wheel because auditors frown on that.”

Also, if you're bent on establishing a domicile elsewhere, be proactive about doing to. Commit to a new house of worship, country club, bank, investment firm, doctor, lawyer and/or accountant in your new home state. License yourself in that new state and register your car there. Move your family there and enroll kids in the local schools. The more criteria you can establish, the better, especially with taxes, community property laws and divorce law hinging on your decision.

“If there’s any ambiguity in your situation, consult your financial advisor and lawyer before you try to change your domicile,” Samay says. “Knowledge and forethought are your best allies when determining or changing your domicile.”