Personal Income Tax: Residency and Domicile
Residency and domicile are terms that are often misunderstood. They require careful analysis by taxpayers and their advisors when contemplating a change of domicile to another state. As many might imagine or know from first-hand experience, it may be difficult to change one’s domicile without a reduced connection with the state where one is currently domiciled. This can may be hard to do for some taxpayers based on their facts and circumstances. Due to chronic budgetary shortfalls and, more importantly, significant unfunded pension and health care liabilities, high income tax states such as but not limited to, California, New York, Connecticut and New Jersey have been conducting numerous residency and domicile audits of wealthy individuals. Over the past several years, these audits have been targeted at those who have relocated to Florida or other lower tax states. The chart below shows the State and Local Individual Income Tax Rates, Unfunded Liabilities and Population Growth that helps explain the states’ necessity to mitigate the loss of revenue due to wealthy individuals relocating to a state with no income or low income tax rates.
1 - Pew Research Center 2012 Report using data from Fiscal Year 2010
2 - California's highest marginal rate is 12.30% with a 1% surcharge on taxable income exceeding $1 million.
3 - This includes a county-level tax that ranges from 1.25% to 3.20% depending on the county
4 - Massachusetts taxes short term capital gains at a rate of 12%
5 - A bill was introduced in the NY Assembly on May 28, 2013 that would raise the top marginal rate to 8.82%.
6 - Illinois law prohibits municipal income taxes
7 - 2000-2010 population growth statistics are from the 2010 US Census Bureau
8 - 2010-2012 population growth estimates are from the US Census Bureau
9 - Residents of NYC are also subject to NY income tax.
10 - Residents of Philadelphia are also subject to PA income tax.
With regards to residency and domicile audits, a recent Pennsylvania case illustrates some of the items that states look at when a taxpayer is attempting to change his or her domicile. Although the result in this case is not surprising, it does provide a timely reminder that changing one’s domicile is very fact dependent and taxpayers should seek advice from professionals who have experience in this area before making a decision to change their domicile.
On June 17, 2013, the Pennsylvania Supreme Court affirmed, without opinion, a Commonwealth Court decision (Richard C. Hvizdak, Petitioner v. Commonwealth of Pennsylvania, Respondent, 50 A3d 788, 04/24/2012), which held that a taxpayer who maintained permanent places of abode in both Pennsylvania and Florida throughout 2004 was a Pennsylvania resident for that year. With an individual income tax rate of 3.07%, Pennsylvania is generally viewed as a low income tax state among states in the Northeast. Even so, the taxpayer in this case sought to exclude $12 million of income by claiming that he was a nonresident.
In Hvizdak, the taxpayer claimed on his 2004 Pennsylvania return that he was a Florida domiciliary during 2004. In addition to his permanent place of abode in Florida, he obtained a Florida driver’s license on August 26, 2004, he registered to vote in Florida on July 4, 2004, worshipped regularly in Florida, participated in social organizations in Florida, belonged to a golf club in Florida, and was listed in the Florida telephone directory. He argued that he was not subject to tax in Pennsylvania on his nonbusiness income or non Pennsylvania business income because he did not spend more than 183 days in Pennsylvania during 2004.
Domicile: For Pennsylvania purposes, as in most states, a domicile is the place an individual intends to be his permanent home and to which he intends to return whenever he may be absent (61 Pa. Code Sec.101.1). A domicile, once established, continues until the individual in question moves to a new location with the bona fide intention of making this his fixed and permanent home. The burden of proof is on the individual asserting a change of domicile to show that the necessary intention existed. (61 Pa. Code Sec.101.3). Domicile differs from the term residency as a person can have multiple residences but can only have one domicile.
The court looked to the taxpayer’s activity in Pennsylvania throughout 2004. He and his wife were married and had joint custody of their minor children. He provided the entire support for his wife and children who still resided at the permanent place of abode in Pennsylvania. The taxpayer was listed in the Pennsylvania telephone directory at his business address where he received mail. The taxpayer’s works of art and furniture were owned by Artifacts LP and were located in Pennsylvania. Based on these facts, the court held that the taxpayer, by his intention and conduct, made Pennsylvania his domicile. Further, because the taxpayer was domiciled in Pennsylvania, his maintenance of a permanent place of abode in Pennsylvania alone was sufficient to make him a Pennsylvania resident for tax purposes. The court further noted that the 183 day rule only applies to individuals that are not domiciled in Pennsylvania (61 Pa. Code Sec.101.5).
Much to Hvizdak’s chagrin, once a taxpayer establishes domicile, he remains in that state until the taxpayer demonstrates the necessary intention and conduct to establish a new domicile. Although obtaining a driver’s license and registering to vote are important facts, it is not necessarily dispositive or conclusive that the taxpayer has changed his domicile. Moreover, due to the fact that the taxpayer continued to have substantive connections with Pennsylvania, the court concluded that the taxpayer’s conduct did not prove that he had a change in domicile from Pennsylvania to Florida in 2004. Citing a Pennsylvania regulation, the court also noted that when a taxpayer attempts to change his domicile only to escape income taxes, this fact alone can jeopardize the ability of a taxpayer to change his domicile. The taxpayer offered no proof or reasons as to why he moved to Florida.
Northeastern States: Considering the issue of domicile outside of Pennsylvania, under the terms of the North Eastern States Tax Officials Association (NESTOA) agreement, the place of domicile is determined by these primary factors:
- Home: Residences owned or rented by the taxpayer
- Time: Where and how the individual spends time during the tax year
- Items “Near and Dear”: Location of possessions of significant sentimental value, heirlooms, etc.
- Active Business Involvement: How the taxpayer earns a living
- Family connections: Reviewed when the first four factors are not conclusive
Understanding residency and domicile rules is critically important for taxpayers when relocating to another state. Among other things, it is advisable to keep a record of days spent at each abode. The actions needed to abandon connections with a former domicile are now, it seems, just as important if not more important than establishing connections in another state. Taxpayers who have changed domicile should assess the tax risk with the state where they were formerly domiciled.