How to Establish State Residency (And Why It Matters)

Moving to a new home in a different state can have major implications for an individual’s taxes.  U.S. taxpayers are taxed at federal and state levels. At the federal level, each individual is taxed according to the same criteria. State tax regulations, however, can vary significantly.

Some states, California, for example, have personal state income tax rates ranging from 1% up to 12.4% for individuals with high incomes. Others, such as Florida and Texas, have no state income tax at all. A full breakdown of personal income tax rates for each state is available here: Personal Income Tax Rates – 2023

With such wide ranges of state tax rates, individuals need to understand how the state they’re considered a resident of impacts their tax exposure.

This is particularly important when individuals and families move from one state to another or split their time between different states. Documenting your residency in the appropriate state is key to ensuring you are taxed correctly and can defend your position in the event of a residency audit.

The Importance of Establishing State Residency

The goal of establishing permanent residency in a particular state is to avoid double taxation, in which an individual is liable for state income taxes in two states at once.

The right tax preparation guidance and tax advisors can help you avoid double taxation. Here are some scenarios in which individuals must be especially careful to establish residency.

• Individuals who commute between states. Example: A Wall Street banker lives in Connecticut and works in New York.

• Individuals who split their time between states. Example: A retired couple spends summers in New York and winters in Florida.

• Individuals moving from one state to another state. Example: A professional moving from Massachusetts to Texas for a new job.

• Remote workers employed by an organization based in one state but who live in another. Example: An employee of a California-based business who lives and works remotely from Washington.

For these individuals, carefully documenting their domicile in a particular state can result in a lower tax burden, smoother tax filing process, and defensible position during a residency audit.

How States Determine Residency

Each state sets its own residency criteria. The best known of these is the 183-day test, in which individuals are considered a resident of that state if they spent over 183 days (half the year) in that state in a calendar year.

This rule is a generalization and some states have differing requirements. Basing your state income tax strategy purely on the 183-day rule can get taxpayers into trouble, because the way  states determine residency is often more complex.

When states conduct residency audits, they typically examine five key factors:

1. Where the individual lives. States seek to understand where ‘home’ is for an individual, including where they intend to return to from trips.

2. Where the individual works. Tax authorities will determine where an individual works or where their business interests are located.

3. Physical presence in the state. States apply the 183-day test, or some variation of it, to determine whether the taxpayer spent sufficient time in the state.

4. Near and dear test. Also called the “teddy bear test,” it determines where an individual’s most cherished possessions are.

5. Family ties. Auditors consider where a taxpayer’s spouse, children, parents, and extended family live.

Many people live and work in more than one state, whether by commuting across state lines daily or spending time in multiple states throughout the year. Fortunately, many states have reciprocity agreements. These exempt taxpayers from selected states from paying income taxes in another. For example, residents of Pennsylvania who work in New Jersey pay tax on their compensation in Pennsylvania and do not pay New Jersey income tax on that compensation.

How to Document State Residency

Most states do not have a formal process to declare state residency but some may provide tools. For example, new residents of Florida may file a Declaration of Domicile with the clerk of the circuit court in their new home county as a way to show their intention to make their new Florida home their principal home.

What’s more important is that taxpayers effectively document their residency in their new state. These actions are evidence that taxpayers can use to demonstrate their domicile in a new state during a residency audit.

•   Apply for a driver’s license in the new state and register your vehicle.

• Register to vote, and vote in primary, special, and general elections.

• Open bank accounts in the new state and close accounts in the old state.

• Purchase or lease a residence.

• Register for a library card.

• File tax returns from the new state.

• Update wills to reflect the laws of the new state.

• Register for services from personal physicians and other medical providers.

These actions indicate to tax authorities that the taxpayer has moved to the new state.

State Residency Audits

Some states — including New York, New Jersey, Massachusetts, and California — are more likely to audit residents who move to a different state. They are among the states with the highest rates of state income tax. When taxpayers move out of these states, particularly high-earning taxpayers, state tax authorities may conduct a residency audit to ensure taxpayers are not avoiding their state tax obligations.

Although these audits are not common, they can be intrusive when they do occur. Auditors will look at cell phone records, travel records, and more to build an accurate picture of where the taxpayer really lives. For this reason, family members should not share credit cards or frequently swap automobiles with toll pass transponders, as these actions could muddy an audit trail.

Smith + Howard: National Tax Advisory Firm

In preparation for any move, the support and guidance of an experienced tax advisor can ensure you take all the required steps to establish residency in your new state and avoid any compliance issues.

At Smith + Howard, our private client tax team is proud to advise taxpayers across the nation on their tax strategy, including all relevant state income tax obligations. We are equipped to represent taxpayers in the event of a state residency audit and support our clients in taking a proactive approach to establishing a new domicile.

To learn more, contact an advisor today.