by Samantha Pahlow, CTFA, AWMA
Wealth Management Chair
In recent years, a growing number of individuals and families have considered changing their state of domicile as a strategy to reduce their state income tax burden. Not surprisingly, states with lower income taxes and taxpayer-friendly structures experienced strong inbound migration according to IRS migration data based on 2021 and 2022 tax return filings. Whether prompted by high state income, estate or property taxes, the decision to change domicile is significant with legal and financial implications.
In this blog, we will explore what it means to change domicile, why someone might consider it and tips for a successful transition.
Domicile versus Residence
It’s essential to distinguish between domicile and residence as both have different meanings and legal and tax implications. A residence is any place where a person lives or stays, and while anyone can have multiple residences, in multiple states, they can only have one domicile at a time. A domicile is a person’s true, primary and permanent home. It is the place they intend to return to after being away. And, if they have multiple residences, their domicile is likely the location where they spend most of their time and potentially have their most substantial and meaningful connections, such as family, social connections and financial interests.
Why Change Domicile?
Many individuals change their state of domicile to reduce state income taxes. States like Florida, Texas and Nevada have no state income tax, making them attractive options for high-income earners or retirees. Other states impose estate or inheritance taxes, which can decrease the wealth passed to heirs, offering an incentive to relocate. Of course, taxes aside, individuals may seek to change domicile for lifestyle reasons such as climate, access to healthcare, proximity to family and more.
How to Establish a New Domicile
Changing domicile isn’t as simple as packing up and moving to a different state. The requirements for establishing a domicile for income tax and estate tax purposes vary by state. Those states with high income or estate taxes will often closely scrutinize domicile changes to ensure individuals genuinely intend to make the new state their permanent home. Along with consulting with tax and legal advisors, here are several tips to consider when changing domicile:
Physical Presence: Buy or lease a home in the new state and spend the majority of the time there, or at least avoid spending the majority of the time in the former state. While there is no set number of days for every state, a common benchmark is 180 days. If there are multiple residences in different states or frequent travel, avoid spending more than half of the year in non-domicile states and maintain strong documentation. Keeping a calendar and receipts from transactions as evidence of a physical presence, especially during the year of transition, should be a strong consideration.
Key Documents: Estate planning documents, driver’s license and voter registration are important documents to update. Also, update mailing addresses with all service providers and file a Declaration of Domicile if the new state offers or requires it. List the new address on all official documents, such as insurance policies, tax returns and credit cards.
Service Providers: Establishing key relationships in the new state provides additional support for documentation. Consider opening a bank account at a local branch and be sure to update to the domicile address on all financial accounts. Find new health care professionals, child and pet care providers and consider a local attorney or accountant with expertise in the new state’s laws.
Personal Connection: Reduce personal ties and memberships in the former state and relocate any personal effects (especially prized possessions). Establish new membership in local clubs, places of worship or other social organizations.
Common Pitfalls to Avoid
The January 1st Trap: Claiming January 1 as the move date on a tax return can be a red flag for auditors.
Receiving Mail in the Prior State: If a home is maintained in the former state, take steps to ensure all mailings are changed to the new home address.
Changing domicile can be complex, especially if one hopes to maintain any ties in their former state. Some states aggressively pursue former residents for taxes and challenge their state of domicile. The burden of proof is always on the taxpayer to demonstrate that their new domicile is their primary home. Those that change domiciles should keep detailed records of the steps taken to establish domicile and the time spent in each state. Anyone choosing to change domiciles should work with a tax advisor to understand the nuances of both the former and new state and be prepared to defend their position if challenged.
Ferguson Wellman, Octavia Group and West Bearing do not provide tax, legal, insurance or medical advice. This material has been prepared for general educational and informational purposes only and not as a substitute for qualified counsel. You should consult qualified professionals to understand how this information may, or may not, apply specifically to you.