Changing Residency for Lower Taxes

With the increase in hybrid and remote work options post-COVID, as well as income tax and estate tax differences across the country, it’s not uncommon for those entering or enjoying retirement, as well as those who are working, to be curious about what changing your residency entails. While a lot can be involved in changing your state of residence, the income and estate tax savings can be substantial.

Along with my fellow advisors in Modera’s Boston office, this conversation comes up regularly with our clients who live in Massachusetts and own (or are considering purchasing) a second home in a state with no income or estate tax, such as Florida or New Hampshire. The reality is that many states with higher or progressive income tax rates (including California, New Jersey, New York, Oregon, Minnesota, and Massachusetts) scrutinize situations where their residents claim a move and changed residency to a low/no income tax state, especially when they maintain close ties and a home in their original state. No state wants to lose tax revenue, especially if rules aren’t followed and the residency change may not be deemed legitimate. Past admonitions to change your driver’s license, voter registration, and doctor’s offices are unlikely to cut it in the face of state auditors reviewing moves.

Many states consider two tests for assessing whether a taxpayer is a resident. The first is the domicile test, which looks at where you live and intend to stay. Five factors are considered, which we’ll explore in more detail, but ultimately the burden of proof is on the taxpayer to show that a move included a domicile change, and often auditors are looking for a corresponding lifestyle change, such as retirement, home upsizing/downsizing, or health issues. If you take a temporary assignment in another state but intend to return to your primary home—especially if your spouse and children remain there—then, while you have left your home state, you have not established a permanent residence in the new state. As a result, your domicile may not change, and your previous state could still have the right to tax your income.

Five factors that auditors evaluate under the domicile residency test include home, business, time, your near and dear, and family. Are you keeping your historic family home or is the home in your new state larger or  does it offer greater land? Are you claiming your prior home as a primary residence for a property tax discount or claiming a capital gains exclusion on the sale of it as a primary residence? If you continue to work in a business, where do you do your work, where are your business ties, and where is the location of the headquarters, your office, or an assistant? Where do you spend your time, especially quality time with family or during holidays? Where do you keep items that are near and dear to you, such as family heirlooms and pictures? Where are your safe deposit boxes? And finally, where do your minor children attend school? Do you have documentation to combat the presumption that both spouses share the same state of domicile?

The second residency test is the “statutory” residency, which has been described as spending 183 or more of 365 days a year in the state, along with owning a primary place of abode. Keep in mind however, that for some states (including NY) spending even a minute there may count as being there for a day, working against someone who wishes to claim residency elsewhere but spends significant time in their former state. The burden of proof is on the taxpayer and keeping records is important. Credit card statements with charges, ATM usage, flight records, EZ pass records, time-tracking apps, and landline and cell phone logs can all be used.

Legally changing residency makes a lot of sense for those seeking income or estate tax relief, though at Modera we’ll always advise you to not let the tax tail wag the dog. Managing taxes is but one factor in what contributes to living your best and financially secure life. One big piece of advice for anyone considering a residency change: marking your move as January 1 may seem convenient for clean tax filings, but auditors will question how you were able to secure movers on New Year’s Day. Receipts showing expenses for movers, and a substantial change in living patterns are both key indicators of a legitimate move, especially if the shift is toward residing in a new state with a home that has previously been used as a second home. Be mindful of the ratio of time spent in your new state relative to your old state (and that time spent traveling will not reflect as time living in your new state).

If exploring residency options is on your mind, please bring it up with your Modera advisor. Knowledge is power, and decisions on where to live are often best made after a series of conversations to understand financial and other implications.