Changing State Domicile

As Congress mulls over the fate of the SALT deduction, a growing trend has emerged from business owners in high-tax states. In recent years, states such as California, New Jersey, and New York have seen significant outflow of business owners, seeking more favorable tax treatment.  

This exodus is driven by a combination of factors, ranging from increases in cost of living, lifestyle considerations, but has been exacerbated by the increased burden of state and local taxation.  

If you are considering a move to a low-tax state, the following article will address the benefits and potential issues that could arise if the move is scrutinized by a state's taxing authority.  

For federal individual income tax purposes, residents are taxable on their nationwide income, regardless of the state source of the income. Conversely, nonresidents of a state are subject to a state's income tax only to the extent that the nonresident derives income from sources within that state. 

"Domicile" is generally defined as "the place at which a person has been physically present and that the person regards as home" as well as a person's true, fixed, principal, and permanent home, to which that person intends to return and remain even though currently residing elsewhere. It is the place with which a person "is most closely associated".

To accomplish a change of domicile, two basic requirements must be met: (1) physical presence at the new location, coupled with (2) an intention to remain there indefinitely or, at minimum, the absence of any intention to go elsewhere. Otherwise stated, "Domicile is manifested by physical presence plus intent." 

The taxpayer asserting a change in domicile must demonstrate there has been a meaningful change sufficient to accomplish a change of domicile. The underlying motive for the domicile change is immaterial so long as there has been a bona fide change.  

When determining intent for a domicile change, most states prioritize the substance of an individual's daily life over formal changes like obtaining a driver's license or registering to vote. The individual's life in the new location should essentially replace their previous life. States typically evaluate five primary factors: time, homes, business connections, family, and possessions. They compare the individual's connections in the new location versus the former location, with stronger ties to the new location increasing the likelihood of the domicile change being respected. 

A common misconception is the "six months and a day" rule, where some believe that spending just over half the year in a new state is sufficient for a domicile change. This is not true. Most states require proof by a "preponderance of the evidence" or "clear and convincing evidence" standard. Simply spending 51% of the year in the new location is unlikely to meet these standards. Ministerial acts alone, like paper changes, are not enough to establish a domicile change. The focus is on the realities of day-to-day life. 

Lower tax rates can be a reason to change legal residence, but taxpayers must understand the requirements to avoid issues with state and local taxing authorities.