Millions of Americans move to different states every year to pursue career opportunities, be close to family, reside in a low-tax state, and many other reasons. Furthermore, due to the COVID-19 pandemic, many people are now working virtually, making it easier for them to reside in the state of their choice.
However, if you have moved to a new state in the past few months, it is best to research tax residency rules for your current and former states, as dual state residency can lead to dual taxation.
The following are residency rules you need to know to avoid dual taxation.
How States Determine Residency
Wondering when does a resident become a nonresident or how states determine residency?
While the specific rules and regulations vary among states, a “state resident” is generally defined as an individual in any state for other than transitory or temporary purposes. An individual’s domicile is considered the place of a permanent home to which the individual will return whenever they leave the state. Most states claim a right to income tax if an individual is a resident and domiciled in a state. In most cases, a hundred percent tax is imposed on the resident’s income from all sources.
However, in some cases, it is possible to get caught in the trap of dual residency, which leads to dual taxation. Some of the most common groups of people who are affected by dual taxation include:
- Retirees with a second home in a different state
- Taxpayers who reside in one state and hold business interests in another
- Individuals who temporarily relocate to another state or overseas
- Individuals who relocated to another state only to return after several years
- Individuals who fail to establish residency in a new state
California Statutory Residency Rules
Out of all states, only seven have no income tax: Alaska, Washington, Nevada, South Dakota, Wyoming, Florida, and Texas. These states are not concerned with residency. However, the remaining 43 states employ 11 different ways to determine residency. We will take a closer look specifically at the California statutory residency rules.
One thing to understand about California rules is that if you are a California resident, the state will impose income tax no matter where you make money. It includes temporary work income, out-of-state pensions, out-of-state real estate, and IRAs.
Furthermore, California also imposes a tax on out-of-state residents who earn an income in California. Income tax is charged even if you move out of California but continue to make an income from within the state. The question is how does California determine residency? Here are some of the factors to consider:
- Location of your main residence
- Location of your family (spouse & children)
- Time spent in and out of the state
- Vehicle registration & state driver’s license
- Location of banks that maintain your bank account
- Voter’s registration
- The permanence of your work assignments in California
- Your social activity locations
Keep in mind this is just a partial list. This document explains California State residency rules. Another tip for vacation homeowners, if you have a vacation home in California (or any other state for that matter) and want to avoid the potential for an audit, it is not a good idea to have your official documents mailed to your vacation home as it might be considered that you reside in the state of that vacation home permanently.
Essential Action Steps When Changing Residency
Changing the residence is a proactive process that takes planning. Courts will consider facts and documents when deciding the state of domicile. Careful documentation is essential. Here are some necessary steps to take when changing residency.
- Mark the date and intent of the move in writing
- File income tax returns for the residence in your new state
- Register your vehicle in the new state
- Attain a driver’s license in your new state as soon as possible
- Revoke homestead claims in the former state. File them in the new state
- Open a bank account in your new state
- Register to vote in your new state
- Modify your mailing address for all documents, including bills, doctor’s appointments, bank and insurance letters, etc.
- Remove social activities in the former state, including involvement in charities and social work
- Retain evidence supporting the date of the move, such as credit card statements, airplane tickets, hotel records, etc.
It is imperative to closely monitor and adhere to all formalities of changing residence, especially if you have previously filed a tax return in the former state. The general rule of thumb is that you have not created a new domicile in your new state until you give up residency in the former state.
What Happens If You Live & Work in Different States?
If you do not reside in the same state that you work in, you will be required to file a nonresident return in the state of your employment. Moreover, you will likely have to submit a resident tax return in the state of your domicile.
The good news is that most states provide a credit to offset taxes imposed by other states. However, keep in mind that not all states do that. Therefore, it is important to consider the specific rules and regulations of both states in question.
Due to the COVID-19 situation, many people have moved to other states due to the flexibility provided by the virtual nature of work. It is important to understand different rules to avoid dual taxation in such cases. A state that follows a 183-day residency rule will consider state residency for tax purposes only if you spend more than half a year in the state.
Windes Can Help You Avoid Dual Taxation
Windes is a leading accounting firm providing a host of Audit, Tax, and Advisory services. We specialize in personalized individual tax services and can provide tailored advice to individuals and families in order to avoid dual taxation. Connect with us today to explore your options.