When a taxpayer is a “resident” of a State which imposes income tax, he has to pay State tax on worldwide income, not just the income earned from sources within that State. If a taxpayer is working and residing overseas for an indefinite period of time and may or may not return to the State where resident before commencing the overseas work assignment, the taxpayer may wish to consider terminating State residency. If successful, terminating State residency means the taxpayer is no longer subject to tax in the State and tax is not due unless income is earned from sources in that State (for example, rental income from a property located in the State).
For tax purposes, a termination is generally signified by filing a “part-year” State tax return in the year the taxpayer begins residence overseas. A tax advisor should definitely be consulted to assist in this overall decision and in determining potential State tax exposure. The taxpayer must take appropriate steps to ensure that he or she can support a position of non-residency in the event the State audits the taxpayer at a later date. This is necessary to help prevent imposition of back State income taxes, penalty and interest charges which can quickly add up to large amounts if several years are involved.
Each State Has Its Own Criteria Regarding Residency
Each State has its own rules regarding what constitutes “residency” in that particular State. They are looking to whether an individual has changed “domicile” to another location. Most States look to various factors in making the determination and while there is no “one-size-fits-all” answer, there are some basic principles to keep in mind. Generally, for example, simply maintaining a bank account or rental property in a State does not necessarily mean the individual is resident or domiciled in the State; however, the more connections that exist, the more likely it is that the State could successfully argue one is a “resident”. The most difficult states include California, South Carolina, Maryland, New York, Virginia, and New Mexico. These States hold a very tight grip on their taxpayers and look for any possible tie that indicates the taxpayer may return to the State in the future (thus, did not change “domicile”).
Domicile is a question of intent. It is established by the individual intending to treat a place as the person’s true, fixed, and permanent home in conjunction with such intent being firmly supported by action. An individual must take specific actions to change domicile. The individual must be physically present in the new domicile and must establish ties that create the new domicile, while severing ties with the old domicile.
A change in domicile will not be accomplished by a temporary or protracted absence. The taxpayer must not intend to return. To change domicile, the taxpayer must demonstrate that he has taken affirmative steps consistent with this intent, which will be subject to close scrutiny.
Eliminate Indicia of State “Residency” as Much as Possible
Taxpayers who are leaving the US for work overseas should discuss their State tax position with a competent tax advisor before trying to break residency in a State. The relevant State law should be examined and the advisor can assist the taxpayer to eliminate as many indices of “residency” as possible. For example, do not renew a driver’s license; change the mailing address on all official and financial documents; pay nonresident State fees when participating in activities such as fishing, hunting, etc.; stop voting in that State.
Simply Moving Overseas Does NOT Mean State Residency has been Terminated
Remember, a State will often be eager to classify an individual as a resident in order to levy income taxes and other fees. On the other hand, it is in the State’s interest to classify an individual as a nonresident in order to deny a tax-funded benefit. (A good example of this is when a State provides “residents” with reduced tuition fees at its Universities). In these perilous times when States are desperate for money, there are more and more challenges of former residents who attempt to change their domicile to another State. Residency audits are on the rise and will continue the upward trend as increasing numbers of people are moving and relocating.
As mentioned, some States are particularly aggressive and become quite adamant on the issue whether a move overseas can qualify a taxpayer as having terminated State residency. For example, the State of Maryland takes the position for its income tax laws that a person may be “legally prohibited” from establishing a domicile in a foreign jurisdiction because of immigration or visa restrictions imposed by the foreign country. For example, an individual who is sent to a foreign country for work purposes may not be allowed to remain in that country for an indefinite period of time as his presence there may be conditioned on continued employment or on good relations with the foreign country. It is Maryland’s position that such an individual remains a Maryland tax resident because he cannot establish a domicile in the foreign country; essentially, the taxpayer “cannot effectuate a change of domicile, regardless of his intent”. In this kind of case, it may possibly be helpful for the individual to establish domicile in another State (such as Florida which has no income tax) prior to moving abroad.
Under the income tax rules of the State of Virginia, one must establish residency in another US State before one can be treated as having abandoned one’s Virginia tax residency. The Virginia tax authorities make clear that if you are a Virginia resident who takes on employment in another country or leaves the United States for any other purpose, the fact that you are living abroad does not mean that you are no longer considered a resident for State income tax purposes. Unless you have established residency in another State, it is Virginia’s position that you will still be considered a tax resident of the State, and you will be required to file Virginia income tax returns and pay tax on your worldwide income, regardless whether it is from sources in or outside of Virginia. More information about Virginia state residency rules is here.
Factors to Look Out For –
- small things such as a held mailing address, in-state dependents, library cards, and association membership can actually be enough for the State to keep a taxpayer on the tax hook.
- purchased or leased a new home or an apartment in the new location?
- moved personal property to the new location?
- obtained permanent employment in the new location?
- canceled state bank/broker accounts and opened new accounts in the new location?
- sold real property in the state or canceled leases?
- issued address change notices?
- voter registration? – if possible, cancel or advise voting body the taxpayer has left the State and is not returning;
- obtained a driver’s license and automobile registration in the new location?
- changed membership in churches and clubs? In general, is the taxpayer involved in the new community?
State income taxes involve serious issues. Due to the different rules that may be applied by each State on the issue of residency, it is best to get proper tax advice on the issue of termination. Making a mistake can be very costly.
Posted June 3, 2021
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