If you have a client who has moved, prepare for a residency audit
It’s like that more than a few of your clients have moved state to state, sometimes from a state with high taxes to one with lower taxes. High-tax states have recognized this trend, and in recent years, unleashed a new weapon to collect revenue from supposedly former citizens: the residency audit.
High-income earners, retirees, and many other taxpayers are increasingly leaving states New York, California, Connecticut, New Jersey, and Illinois for such low- or no-tax states as Florida, Arizona, Nevada, Wyoming, or Texas. Tax reform’s limiting of state and local tax SALT deductions to $10,000 may be exacerbating this exodus. In the ongoing fight for revenue, high-tax states are intensifying efforts to claim that some taxpayers changing their residence still maintain enough ties to their former state to require payment of taxes in those states.
New York reportedly pursued thousands of non-residency audits annually in recent years, collecting millions of dollars. The California Franchise Tax Board has also secured a reputation of aggressiveness – to the point where some California tax professionals said they’d much rather deal with the IRS.
States win most of these cases, and residency audits tend to be repeated even if a taxpayer clears the first examination.
Time and intent are keys
Your client’s state of domicile, or residency, determines where they pay state personal income tax. Typically, domicile is defined as the place where an individual maintains their permanent abode and where they intend to return from any absence. Some states also subject statutory residents to their taxes; statutory residence is determined by the amount of time an individual spends in a state, usually about 183 days a year.
Some states – Minnesota, for one – proposed defining residence using a significantly lower number of days. Some states make exceptions for military personnel in active service and for individuals receiving extended medical treatment.
Most audits pivot on establishing your client’s intent to make the new location their permanent home and involve taxpayers maintaining more than one “permanent” abode. Which state has the greater connection for the taxpayer?
Questions auditors often ask
The burden of proof in these investigations is on your client. Questions concerning residency include:
- Did your client obtain a homestead exemption in one state?
- In which state do they support a spouse and children?
- In what state does the spouse live, and where do the children attend school?
- In which state does your client maintain television and internet connections?
- In which does does your client worship regularly?
- Where are they registered to drive and vote?
- In which state do they maintain sporting licenses?
- In which state does your client file taxes, and maintain financial connections such as banking or safe deposit boxes
- Where is their doctor or veterinarian?
- Where do they maintain professional licenses or group connections?
- Where are their ATM records from?
- Where are the local charities they support with involvement beyond contributions. Note that states vary in terms of how much importance they attach to participation in charities and social organizations for residency audits.
Red flags to trigger audits include a client continuing to have business ties to a former state, or a client moving around the time of a big jump in taxable income or a major sale of a business or investments. Tax authorities also tend to look at professions that require extensive travel, such as consultants, professional athletes, or entertainers, as well as the owners of a business that itself recently relocated to a low-tax state.
How to prove residency
Even a client who has legitimately moved may find need to prove their case to an auditor. Here’s where you can help.
These audits are battles of records. State auditors will review a variety of information, from credit card statements – where charges were incurred, where the bill is sent, and the location of the checking account to pay the bill – as well as documents such as freeway toll charges and records of airline frequent-flier miles.
Your audited client should have a variety of documents that detail their past daily activities and provide an overview of their residency. Examples include a calendar detailing what state they’re in every day, documents proving ties to the new state such as a change-of-address form, and documents proving sale of a previous home and the date and reason for the move.
Technology that could help your client prove new residency includes GPS, geo-location, and cell phone information to track days and hours in various locations. There are also apps that can help a client track days in a state.
Finally, learn the statute of limitations for your client’s previous state to conduct residency audits.