Do you have two homes in different states? Determining the state to which you pay income taxes can be quite complex. States are becoming more aggressive in determining who should be filing a state income tax return in their state. It isn't just a matter of deciding to pay taxes in the state which has the lowest tax rate, but it is typically based on the quality and quantity of your contacts or time spent in each state. So how do you establish residency in a state? There are two common ways that residency is established for tax purposes, although the rules vary from state to state.
The first way to establish residency is based on your domicile. You can only have one domicile which is defined as the place that is your fixed and permanent home and principal establishment, to which you return when you are living or working temporarily in another state or country. To change your domicile, you must abandon a former domicile and physically move and establish permanency in another location.
The second factor is time. Most states require that you spend more than 183 days per year in the new state. This also varies between states. For example, Hawaii requires you to maintain a permanent home for more than 200 days to qualify. States may look at many different factors such as where you obtain your driver's license, register your vehicles, open bank accounts, register to vote, conduct business, and go to your doctor, dentist, or lawyer. Some states may also require you to file a Declaration of Domicile to determine residency.
States with high income tax rates are particularly interested in conducting residency audits on part-year residents and nonresidents with state contacts. If you can establish residency in the state with the lower taxes, then taxation by the higher-tax state may be limited to in-state income. However, some states have reciprocity with each other, and income earned in a nonresident state may not be subject to state income tax. For example, if you are an Illinois resident who works in Wisconsin, you are not subject to Wisconsin income tax on wages, salaries, tips or commissions received from employers in Wisconsin. Likewise, a Wisconsin resident earning wages in Illinois will not be subject to pay income tax in Illinois. However, not all states have reciprocity agreements with other states.
If you do have to go through a residency audit, documentation is key to proving your permanent residency. Save credit card statements, utility bills, and bank statements. Join clubs and religious organizations, change your status to a nonresident in your former state, inform the IRS of your address change, and change your address on all legal documents.
These are just a few ways to help prove your residency in an audit. Be consistent too. For example, don't move to another state and claim residency and then register your car insurance in another state for lower rates.
Please feel free to contact Kakenmaster & Associates if you have questions on how to establish residency in another state and how it could affect your state income tax return.