Editor: Kevin D. Anderson, CPA, J.D.
The COVID-19 pandemic drastically altered how U.S. businesses operate and where Americans work. Over a year into the pandemic, many Americans continue to work remotely and are unsure when they will return to the office, while others left their primary residences to stay in second or vacation homes or to care for family members. The shift toward permanent teleworking from, or long-term, temporary living arrangements in, states other than an individual's pre-2020 employment location or place of abode has income tax consequences such as dual residency, which can create double taxation. This item discusses the difference between statutory residency and domiciliary residency and how both can affect personal income taxes.
Domiciliary and statutory residency
The difference between resident and nonresident status can affect state taxpayers greatly. Residents are normally taxed on their worldwide income, while nonresidents are usually taxed only on state-source income. There are two ways an individual can be considered a resident for state personal income tax purposes: (1) domicile or (2) statutory residency.
Domicile is defined differently depending on the state, but in general it is the state where a person's principal place of abode is located and to which a person intends to return. Domicile is determined based on multiple pieces of evidence including, but not limited to, the place of principal residence, voter registration state, the issuing state of a driver's license, the state where government mail is received, and the amount of time spent in a state. Some states, such as Massachusetts and New Jersey, also consider a person's family ties within the state (N.J. Div. of Tax., Informational Memo GIT-6 (December 2020); Massachusetts Dep't of Rev., Technical Information Release (TIR) 12-10 (12/12/12)). An individual can only have one domicile, and it remains unchanged until clear-cut evidence is shown to prove domicile has changed.
Documentation should be maintained to prove a change in domicile. Factors that demonstrate evidence of intent to switch domicile include:
- Buying a home in the new state;
- Moving belongings to the new state;
- Obtaining a new driver's license in the new state;
- Registering a vehicle in the new state;
- Registering to vote in the new state; or
- Engaging medical professionals in the new state.
If a taxpayer chooses to move back to his or her original domicile after being away even one or two years, this action could negatively affect the individual's assertion that the original domicile was changed. It is unlikely that a taxpayer who left his or her state for the duration of the pandemic with the intent to move back will convince a state that his or her domicile has changed.
Compared to the multiple factors used in determining domicile, the test for statutory residence is relatively simple. Under the law of many states, a statutory resident is an individual who maintains a dwelling in the state and spends more than 183 days (or in some states a different number of days such as 182 or 184) in that state. The taxpayer usually bears the burden of proving he or she is not a resident of a state. To limit the possibility of becoming a statutory resident, a taxpayer must keep records showing that he or she did not exceed the 183-day limit. The definition of "dwelling" varies state-by-state but generally will not include dwellings that are seasonal/unwinterized or lack a kitchen and bathrooms.
The following is an example of how an individual can be considered a statutory resident in one state while still being considered domiciled in his or her original or home state.
A taxpayer considers Arizona as the domicile state and owns a house there, is issued an Arizona driver's license, is registered to vote in Arizona, and maintains bank accounts with an Arizona financial institution. The taxpayer also rents an apartment in New Mexico where she works four days a week. Most of the taxpayer's family and economic ties are in Arizona. The taxpayer spent 180 days in Arizona and 185 in New Mexico during an entire year. The taxpayer is considered a statutory resident of New Mexico for the tax year since she spent 185 or more days in the state (which New Mexico sets as the threshold) and maintained a permanent place of abode there. The taxpayer is also a domiciliary resident of Arizona under these facts. Thus, she is a resident of two states.
The taxpayer in the previous example is now subject to dual taxation. Both New Mexico and Arizona can tax her on her total income because she qualifies as a resident in both states. Numerous states allow an individual tax credit for taxes paid to other jurisdictions, but the extent of the credit varies depending on the state. Generally, the state of domicile allows an income tax credit for taxes paid to other states for income that is also taxable in the domicile state. It is less clear how statutory resident states treat credits for income tax paid to the domicile state. For example, in Oklahoma, taxpayers who have claimed a credit for taxes paid to another state on the other state's income tax return do not qualify for an Oklahoma credit based on the same income (Okla. Admin. Code §710:50-15-72).
Tax credits are usually not available for every type of income (e.g., dividends, capital gains, or intangibles). Massachusetts, for example, allows a credit to statutory resident taxpayers on income sourced to the domicile state in addition to any unsourced income (Mass. Gen. Laws ch. 62, §6(a)). On the other hand, New York will not provide a credit for unsourced income (Edelman, 80 N.Y.S.3d 241 (N.Y. App. Div. 2018)). These two conflicting laws could result in dual taxation of unsourced income for a taxpayer that is both a Massachusetts domiciliary and a New York statutory resident. Additionally, some states, such as Vermont, only allow statutory resident credits for taxes paid to other states if the domicile state adopts similar provisions. This law could therefore fail to offset dual taxation if a Vermont statutory resident is domiciled in a state without matching credits for taxes paid. It is also important to note that some dual taxation will only be partially offset due to states having different tax rates, or laws allowing for only partial credit offsets.
Planning ahead to mitigate potential double taxation
The COVID-19 pandemic has generated many new questions surrounding residency tax laws, including whether a state will alter its normal tax residency rules for employees who have relocated during the pandemic. While some state tax authorities have issued guidance on this question, others have yet to do so.
Many Americans left their domicile states to telework from vacation or second homes or to care for family members in other states. Although their absence from their domicile state may have been intended initially to be short-lived, the pandemic continues. As a result, a number of Americans will find themselves confronting a dual-residency dilemma. Due to the two definitions of residents, and the potential risk of multiple taxation resulting from individual state limits on "other state tax credits," taxpayers and their advisers may need to address the dual-residency dilemma for 2020 and should also plan ahead to mitigate any potential dual-residency issues for 2021.
Kevin D. Anderson, CPA, J.D., is a managing director, National Tax Office, with BDO USA LLP in Washington, D.C.
For additional information about these items, contact Mr. Anderson at 202-644-5413 or firstname.lastname@example.org.
Contributors are members of or associated with BDO USA LLP.