Every day, thousands of people move from high-income tax states to states with no income tax-more than those who move from states with no tax to those with high taxes. While the numbers can’t determine how many of these moves were actually inspired by tax avoidance, the lopsided figures have caught the attention of auditors in high tax states who believe many of the relocations are not genuine.
States known for high-income tax rates include California (top bracket of 9.3%), New Jersey (top bracket of 8.97%), and Iowa (top bracket of 8.98%).1 States with no income tax include Florida, Nevada, Texas, Washington, Alaska, South Dakota, Wyoming, New Hampshire, and Tennessee.2
The risk of an audit when moving from a high-income tax state to a state with no income tax is becoming increasingly great. Massachusetts has added additional auditors to focus solely on this issue. Meanwhile, New York has increased revenue from audits by nearly 35% over a one-year period. The Wall Street Journal picked up on this trend and recently cautioned its readers that a move to a no income tax state “can trigger a painful audit – and a hefty bill – from the high-tax jurisdiction you thought you had left behind.”
There is no bright-line test to establish a “domicile” and as a result, tax auditors frequently balance several subjective factors. These may include the location of the business, family, and social ties, a comparison of the new residence and any part-time residence retained in the old state, and the location of personal valuables. Specific red flags include homes in more than one state and sales for large dollar amounts of investment property or intangible securities immediately after relocating to a no income tax state.
Auditors from New York have been known to demand three years' worth of appointment books or calendars, three years of personal and business credit card statements, and three years of phone bills for both states. Because domicile involves intent, the bottom line is whether you truly have transferred your life to a new state. Even something as innocuous as retaining a safe deposit box in the old state can be problematic. In the case of an audit, the location of personal valuables can be an indication of your true domicile, as most people keep valuable possessions in close proximity.
Accordingly, if you are planning such a move in the future, it is imperative that you take proactive measures to demonstrate the move truly is genuine. Actions that can help establish a domicile in a new state include registering to vote, obtaining a driver’s license, registering your car in the new state, changing addresses on mail, bills, and other important documents, joining clubs, executing a new will in the new state, and bringing all personal valuables with you. Most importantly, if you feel you are at an elevated risk for an audit, you should seek legal counsel to help establish your new domicile.
1Rates as of January 1, 2007
2New Hampshire and Tennessee only tax interest and dividends.