Tax considerations when deciding on a state for permanent residency

When it comes to state income tax liability, where you live can make a big difference in how much you owe.

State taxes can take a double-digit bite out of your wages and investment income in some states. New York’s top marginal rate is 10.9% while California tops out at 13.3%, according to research by the Tax Foundation. But in places like Texas and Florida, state tax authorities don’t levy an income tax at all.

This leads to an important point: If you own multiple homes and one is in a state with lower tax rates, claiming residency there could result in substantial income tax savings.

Stuart Green, family office senior trust advisor in Wells Fargo Wealth & Investment Management, says state income taxes often come up in client conversations.

“Very few people are going to uproot their lives that much over tax liability,” Green says. “But there are people who say, ‘I love the idea of having a home in Florida, or I already have a home in Florida — how much more time do I need to spend there in order to benefit?’”

Establishing domicile — and proving you’ve moved

On a basic level, the domicile concept is simple. It is the location where you are the most settled, have a permanent connection, and intend to return when absent — in other words, your true, fixed, permanent home. Establishing your legal domicile has many impacts, including to your state income taxes. Even if you move to a new state, your old state may still consider you a resident for tax purposes, Green says.

“The onus is on the individual who owns homes in multiple states to have evidence that they really have switched their domicile,” Green says. “In addition to actually spending at least six months and a day in the state of choice, you need to be able to substantiate that.” There’s no single factor that proves, in every state, that you’ve moved your primary residence elsewhere, he says. Rather, tax authorities will consider the totality of the evidence.

Generally, you need to prove that your primary residence is in that state and that you intend for it to be your permanent home. Several steps can help you make the case, Green says, including:

• Having an appropriately sized primary home in the new state. It could raise red flags if you own one or more homes that are much larger than the one you are claiming as your primary residence.
• Registering to vote, getting a new driver’s license, and registering your car in the new state.
• Moving personal property with sentimental value to the new state.
• Having primary bank accounts and a safe deposit box in the new state.
• Moving financial and administrative functions in a business you own to the new state.
• Keeping a calendar or other log to document when you’re in the new state and saving travel records and receipts to document spending there.

Some states also have specific requirements to prove you no longer live there. California, for example, might claim you as a resident if you haven’t properly “abandoned” your California home. Others have steps you can take to formally establish residency. Florida allows you to sign a “declaration of domicile” to show you’re a resident.

The details vary depending on the states involved. It’s important, Green says, to consult a tax professional who understands the rules for guidance.

Multistate tax liability can happen

In some cases, Green notes, taxpayers can end up owing income taxes in more than one state — no matter where they’ve established residency.

Income tax may be owed in the state where it was earned, regardless of where you live. If you travel to another state to provide consulting services or owned property that generated rental income in another state, it’s likely you’ll owe state income tax where that income originated. Green says the state you live in will give you a credit for taxes paid on income earned elsewhere, so you don’t end up paying twice.

During the year you move your residency from one state to another, Green says, you’ll likely need to file partial-year tax returns in both states (assuming they both have income taxes). That may, however, create opportunities for tax savings.

For example, profits from the sale of intangible assets, such as stock, are usually taxed in your state of residency. So deferring those investment gains until you’re residing in the lower-tax state could lower your tax exposure.

“This is another reason why it’s important to consult a skilled tax advisor who can properly allocate your income and file the appropriate returns,” Green says. “This can help you avoid overpaying, or underpaying, tax to any state.”