The workplace has gone through a significant evolution as a result of the COVID-19 pandemic. Most commonly, there has been a major shift towards remote work, which has only accelerated because of the pandemic, resulting in states responding with more scrutiny and new policies that have triggered potential tax implications for persons seeking to move from one state to another. For those not moving in conjunction with retirement and/or selling a business, it is likely that wage income and distributive shares of income from an owned business may be taxed by other states, even if an individual moved to an entirely new state.
Given this, state-residency audits are becoming more prevalent and a common tactic for authorities to determine true home-state residency, which can lead to conclusions that people who moved out of state never severed their residency, leading to tax appeals and even tax litigation. One major component of any residency audit involves comparing time spent in the auditing state as compared to the state of residency, and even other states.
Your ability to defend the validity of your move will depend on how well you document your records. The most-common records that are requested on state-residency audits are cell-phone records, credit-card records, and insurance documents, and if you cannot provide them, states commonly subpoena these records directly from the phone companies, credit-card firms, and insurance companies.
A primary reason that auditors request these records is to establish where you (and your spouse) were during the years under audit. Your primary defense on a residency audit is a strong offense in terms of maintaining your own documentation. Direct-support documentation (i.e. plane tickets, gas receipts, food and lodging records) in support of your itinerary calendar is a plus. Without such an itinerary, you will be on the defensive with the state assuming any undocumented time was spent in the state.
What factors determine where your true home is?
States have a standard maxim on residency: your home state remains your home state until you have established a new state as your home state. If you move from one state and cannot establish that your domicile (home state) has changed, then the former state will argue your domicile has not changed. Your intent to change your domicile is key, but unfortunately the conclusion on domicile is really a subjective opinion. Having a majority of the indicators in your favor is beneficial. To the extent you can document these indicators, you should do so. This includes relicensing your vehicles in the new state of residency, changing your driver’s licenses, insuring of property, relocating property, changing business and personal relationships, and changing an address where mail is received. Some audits are even looking into indicators, such as the location of your primary physician and dentist, where you contribute social-media reviews, and even the physical location of pets.
The most-important indicators of the intent to change domicile includes your work, living quarters, and the location of your family. If one moved to a new state in conjunction with a new job, that’s obviously a good fact. Even a retirement in conjunction with the move is not necessarily a negative. The other two major indicators can be much thornier. Expect disagreement with state auditors when someone moves to a new state and buys or rents a new house or apartment — but does not sell the old place. Which is the home now? Likewise, situations where a spouse may live in another state may invite scrutiny as well.
How does working remotely and/or out of another state for some time affect one’s taxes?
There is no single clear tax answer, although where you are subject to state tax is basically limited to either your home (where you are living and working), and your employer base of operations.
Employers have had similar issues — both for state wage withholding as well as questions of direct tax on the employers by the states where employees are working remotely. Logic would argue that the state where you work is the state with the right to tax you, and when your location of work changes from an employer location to your home, that the tax sourcing of your wages should follow you. That unfortunately is not being universally applied. One recent example of this involves the states of Massachusetts and New Hampshire.
Massachusetts has an income tax on wages, while New Hampshire does not. Massachusetts has insisted that Massachusetts tax still applies on the wages of New Hampshire resident employees who, as a result of COVID-driven plant closures in Massachusetts, were working from home. New Hampshire sued Massachusetts and requested the U.S. Supreme Court hear the case, but it declined to do so.
It’s important to note that numerous federal bills have been introduced through the years that could limit the states’ ability to tax income of employees working remotely, or who work in multiple states, but none of those bills has achieved enough political traction to make passage likely.
Whether you work from home permanently or temporarily, due to COVID or other reason, there is currently no clear answer on state authority to tax your wages.
How can someone looking to optimize their taxes do so by moving to another state?
Your ability to minimize your taxes by moving to a state with a lower rate, or no income tax at all, depends on the nature of your income before and after the move. If your sources of income after the move are dividends, interest, and payments from a qualified retirement plan like an IRA or a 401(k) plan, the only state that can legally tax those income sources is your current state of domicile. You may be able to argue a similar position when you sell your business, but that depends on the way the business gets sold. If you sell the assets of your business, the states where the assets are located will have the right to tax the income associated with that gain.
One more item to note, if you expect a big gain on the sale of a business at some point in the future, plan your move to take place at least one year in advance of the year of sale. The state mechanics of taxing part-year residents could result in the gain being at least indirectly taxed if the gain happens in the year you move.
As these are complicated areas of taxation, it is always encouraged that individuals seek professional counsel from a qualified tax adviser.
Robin Brand, CPA, is a tax principal with The Bonadio Group. She brings more than 20 years of corporate, international and multistate tax experience to the tax practice.