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Residency determinations are relevant for purposes of marital dissolutions, education, probate proceedings, property tax determinations, voter’s registration and . . . income taxes. Individuals often erroneously believe they are not residents for tax purposes simply because they spend significant amounts of time or maintain homes outside of a certain state.
Massive reductions in the IRS budget and workforce are mostly eliminating the ability of state taxing authorities to “piggy-back” on whatever is left of IRS enforcement efforts. Accordingly, in an effort to fund their own operational budgets and step up their own examination activities, states have been aggressively hiring recently departed IRS examiners, collectors and data analysts.
Former IRS Commissioner Chuck Rettig, and now a tax lawyer at the law firm Chamberlain Hrdlicka, has represented many taxpayers in state residency audits over the past four decades. He spoke to me for this article, telling me “Wealthy individuals maintaining homes in more than one state now face an increased risk of their worldwide income being subjected to tax in multiple states based on possibly arbitrary determinations of their residency status. States typically only tax nonresidents on income sourced within the state. Individuals must be especially careful to avoid inadvertently becoming a Rettig said “For tax purposes, residency examinations are designed to identify individuals maintaining a sufficient physical presence within a specific state and/or receiving substantial benefits and protections from the state justifying their contribution to the support of that state.” Generally, individuals present in a state for a mere “temporary or transitory purpose” are deemed to not avail themselves of the benefits of residency and should not be considered residents for income tax purposes.
Resident. In most states, the statutory concept of a “resident” includes any individual who is (i) physically present in the state for other than a “temporary or transitory purpose,” or (ii) domiciled in the state, but physically located outside the state for a “temporary or transitory purpose.” The term “temporary or transitory purpose” depends upon the facts and circumstances of each particular case, although it generally encompasses physical presence within the state for a particular purpose of a specified duration. A tax resident generally continues to be a resident even though absent from the state on a temporary or transitory basis. A “part-year resident” is any individual who is a resident for part of the year and a nonresident for the remaining part of the year. The term “nonresident” includes every individual other than a resident.
Domicile. Domicile requires both general physical presence in a particular location and the intent to remain there indefinitely. The key distinction between residence and domicile is intent. Residence requires voluntary physical presence as a non-transient inhabitant; domicile requires both physical presence in a certain location and an intent to make that location the individual’s one permanent home. Domicile is the place where an individual intends to return whenever they are physically present elsewhere. With respect to domicile, it is the intention of the individual that is important. With respect to residency, it is the actions of the individual that tend to be the most important.
An individual can only have one domicile and, once acquired, it is retained until another is thereafter acquired. A new domicile is acquired by an actual change of residence accompanied by actions that clearly demonstrate a current intention to abandon an old domicile and establish a new one. To avoid becoming a tax resident of any particular state, the individual must avoid being deemed either a resident or a domiciliary of that state.
Presumptions. There is often a general presumption that individuals physically present within a state for less than six months during the tax year (who are domiciled and maintain their personal residence outside the state) will not be considered residents provided they do not engage in any activity or conduct within the state other than that of a seasonable visitor, tourist or guest. Similarly, there is often a general presumption that individuals physically present within the state for more than nine months are considered tax residents. Finally, most states have various statutory “safe harbors” providing that an individual is no longer a tax resident if outside the state for a lengthy continuous period of time (frequently a consecutive period of 18 months or more). These presumptions are not conclusive and may be overcome by evidence that physical presence, even if for more than nine months during the tax year, was merely for a temporary or transitory purpose.
Residency Examinations. John Hackney, also a longtime tax lawyer at Chamberlain Hrdlicka, who specializes in representing taxpayers in tax controversies, told me “Residency examinations often involve a highly intrusive process digging into deeply personal facts by auditors making after-the-fact determinations regarding an individual’s physical presence and intentions. Auditors frequently canvas in-state neighborhoods in an effort to identify some degree of presence justifying a residency examination. They also scour out-of-state neighborhoods to support a theory that presence outside the state was de minimis and not controlling from a residency perspective.”
The determination of a wealthy individual’s state of residency is often subject to various interpretations of relevant facts and events. “Given competing facts, many residency examinations settle on some basis less than a clear determination of residency or non-residency,” said Hackney. As such, some have characterized residency examinations as a form of “money grab” from wealthy individuals by desperate states seeking to fund their operations.
Tam Rettig, a former longtime residency auditor for the California Franchise Tax Board, told me that “actual time spent in a state is only one factor to be considered. For tax purposes, a residency determination depends upon an overall evaluation of the individual’s ‘closest connections’ during each tax year.” The contacts/connections that a person maintains are important objective indications of whether presence in or absence from the state is for a “temporary or transitory purpose.” The state with which an individual has the closest connections during the tax year is typically their state of residence.
Such connections are important both as a measure of the benefits and protections which the individual received from the state, and also as an objective indication of whether the individual entered or left the state for temporary or transitory purposes. If seeking to change domicile, it is often recommended to sever substantially all connections with the former state of domicile, physically relocate out of state and demonstrate a clear, subjective intent to not return. Once relocated, filing of a nonresident return reporting income sourced in the former state should be considered to commence any applicable statutes of limitations on assessment.
Mr. Rettig summed it by telling me “Residency determinations are unpredictable and often perceived as inequitable, designed to achieve a pre-determined conclusion supporting residency.” Taxpayer favorable facts are deemed to be insubstantial and unfavorable facts are often labeled “substantial and controlling.” Individuals maintaining significant personal and business contacts in more than one state remain exposed to potentially arbitrary residency determinations by hungry, enhanced state taxing authorities looking to replenish depleted operating budgets.
The author thanks Mr. and Mrs. Rettig and Mr. Hackney for their generous contributions to this article which go far beyond the quoted material.