Moving to another state? Getting a second home elsewhere? Here’s what you need to know to avoid a big tax hit and audit.
By Nishant Mittal
You packed your bags and moved to Florida. It feels like you’ve cut ties with New York but it turns out that breaking up with your former home state is hard to do. Just as you’ve settled into your new home, New York tax authorities challenge your ‘non-resident’ status on your tax return.
It’s a common scenario for “snowbirds” who relocate to tax-friendly states like Florida, Texas, and others who don’t collect income tax. Thousands suffer through residency audits yearly, and proving you spent less than half the year in a high-tax state like New York can have a big impact on your tax bill. It’s the difference between paying no income tax and an average $67,000 in an audit in states like New York. Notorious for their attention to detail, auditors will poke and prod to verify your true residency.
It should be noted that even though we use New York State as a reference point in this article, these issues are substantially the same for other big and increasingly aggressive tax jurisdictions such as California, New Jersey, Connecticut, and even New York City.
Demystifying the residency audit
Juggling multiple homes means that you may juggle multiple tax returns come tax season. If you have ties to a state that has income tax and you decide to file in that state, you generally have the option to file as a full-year resident, part-year resident or non-resident. Your classification will determine how much you owe the state in taxes. It is important to note that just because taxpayers believe they are a part-time resident or a non-resident, it doesn’t take them off the hook as a full-time tax resident.
In New York, for example, the first step of an audit is to determine one’s domicile. This is one way New York residency is determined legally. A second test is something called statutory residency. We’ll walk through both. Domicile is of particular importance because New York domiciliaries pay state income taxes on all income earned. Ouch. Below are some of the factors that the state looks at when determining domicile.
In the event of a residency audit, the state will look at detailed records to verify (or disprove!) your non-resident status. Recent stats from the state of New York show that 52% of those audited lose their audits. This means they may have claimed they were a non-resident or part-year resident, only to be proven wrong by the state. This ugly outcome not only results in more taxes owed but also significant penalties, interest, legal fees, and a time-intensive intrusion into personal life.
So you think you moved your full-time residence. The taxman isn’t convinced.
You can have multiple residences, but you can only have one domicile. Your domicile is where you call home and where you intend to return eventually. This idea of intent is an auditor’s key to defining domicile.
Establishing domicile is not as simple as getting a new driver’s license or filing for a change of address. Taxpayers need to pay extreme attention to the details to avoid being double taxed. In New York, for example, the state looks at many factors to determine your full-time residence:
Your “home”: They’ll look at the primary address on your tax return, bank statements and other bills. Auditors may look at your phone usage. They’ll analyze telephone services at each residence including the nature of the listing, the type of service features, and the activity at the location.
Voter, auto, boating and airplane registrations also are key. The size and value of your home may be compared to your other residences. Some auditors may also analyze what types of “employees” (domestic help, groundskeepers, chauffeurs, etc.) are employed at each location.
Business ties: “Active business involvement” including, “active participation in a New York trade, business, occupation or profession and/or substantial investment in, and management of, any New York-based closely held business such as a sole proprietorship, partnership, limited liability company and corporation.”
Near & dear: “There’s no place like your domicile” doesn’t have the same ring as “no place like home,” but the warm and fuzzy feeling that home brings helps to determine domicile. This is also known as the “teddy bear test.” It’s where auditors assess the things you hold “near and dear” like art collections or family heirlooms. They’ll ask for insurance policies and other records to analyze these details and see where your most precious items are stored.
Time: While intent plays a big factor in determining domicile in New York, there’s another factor that can make it very difficult to give up your New York domicile — and that is time. If you continue to spend more days during the year in New York compared to the state that you are now claiming as your new domicile, auditors will argue that you never ‘left’ New York. Their claim: it is only reasonable to expect that you spend most of your time at ‘home.’
If however, you are able to convince them of your clear intent to leave and successfully establish that you did indeed change your domicile, auditors will then likely turn to what is called the statutory residency test. If the state finds that the individual “maintains a permanent place of abode” in New York, “and spends more than 183 days” a year there, they may be determined a resident of New York for tax purposes. This 183 number applies in many states, and is the day count that many people keep a close eye on if they are juggling multiple residences. Pay close attention to your state’s definition of a day. In New York, for example, any amount of time counts as a day.
Under the rules of statutory residency, you can be considered a resident of New York if you maintain a permanent place of abode—somewhere “maintained” that is “suitable for living year-round.” If you have unrestricted use of the residence, even if someone else is covering the expenses, for more than 11 months in the year it qualifies as permanent place of abode.
A taxpayer who maintains a permanent place of abode but isn’t a domiciliary of New York is treated as a statutory resident after spending 183 days of the taxable year in New York. And for state income tax purposes, that is practically the same as not having changed your domicile out of New York at all. That is, you get to pay taxes on all of your income from all sources as if you never left New York.
Always be counting days
One of the most straightforward ways of avoiding NY residency is to spend less than 183 days in the state. What’s most important when faced with a residency audit is having detailed records of where you did spend your time during the year(s) in question. Be prepared to credibly prove the ‘negative’ i.e., you were not in New York on said days. You also have to be diligent about what makes up your day count. Depending on where you spend your time, make sure you know your states’ residency requirements. In New York, the law states that the burden of proof is on the taxpayer and the evidence must be “clear and convincing.” In other words, you are ‘guilty until you can prove otherwise.’ It can feel like the cards are stacked against you in a residency audit.
New York’s guidelines require “contemporaneously maintained diaries or calendars supported by credible testimony.” Auditors are relentless about details and will often go well beyond spot-checking diaries.
Residency audits can be extremely invasive, and auditors will go to the extreme of checking property records, banking statements, EZ pass records, cell phone records obtained under subpoena from your mobile carrier, and many other details of a taxpayer’s personal information. Some even go to lengths of interviewing doormen or verifying doctors’ appointments.
You need to be prepared with a strong audit defense. The more thorough and prepared you are, the more you increase your chances of avoiding a bigger tax bill. The records you keep need to be reliable and well-supported. Individuals can be audited every few years. In some states like California, they can review every tax return ever filed. That means you not only need to keep track of your whereabouts with painstaking detail, you also need to be organized enough to pull those records from several years ago.
Residency requirements can vary by state and the guidelines can be nebulous. Get expert advice on the issue. You don’t want to go it alone when navigating residency rules. If you’re living or working across multiple states, talk to your CPA or legal team to understand your state’s residency requirements for tax purposes.
Technology makes it easierSound like a lot of work? It is. Keeping track of this manually is cumbersome and painful. That’s why we built Monaeo Personal Edition. The companion mobile app privately and automatically counts your days for you by working in the background of your smartphone while its sophisticated algorithms produce reliable reports and analytics you need to first establish your residency status and then prove where you were throughout the tax year in an audit. Monaeo is the only application whose data has been used in audits, and even with aggressive jurisdictions like NY state and New York City. Clients who have used Monaeo’s data in audits have had 100% success rate in defending their non-residency or part-year residency status, and have saved tens or hundreds of thousands of dollars, even millions. Auditors have many legal and digital tools at their disposal, but many people still fight audits with paper receipts and calendars. We are now in a time when we can put these manual, paper-based methods aside — which leave us practically defenseless — and leverage the technology that’s right at our fingertips.
Nothing in this article should be considered or construed as tax advice. Monaeo does not dispense tax advice and always recommends that taxpayers consult their accountants or lawyers.