Wealth migration and change of domicile

Editor: Robert Venables, CPA, J.D., LL.M.

Americans are continuing to pack their bags, fleeing high-cost-of-living areas and relocating to states with more favorable tax climates. This migration trend, influenced by a combination of economic and lifestyle factors, highlights the profound impact of state taxation on an individual’s choice of residency. (See, e.g., Milnes, “Americans Are Moving to the Most Tax-Friendly States in the Country,” MoneyGeek (May 28, 2024), and Loughead, “Americans Moved to Low-Tax States in 2023,” Tax Foundation (Jan. 9, 2024). But cf. Mazerov, “State Taxes Have a Minimal Impact on People’s Interstate Moves,” Center on Budget and Policy Priorities (Aug. 9, 2023).)

The COVID-19 pandemic sparked a drastic shift in both how people work — as remote-work arrangements became commonplace — and how remote work was viewed. In today’s digital age, advancements in remote-work technology have made it easier for individuals to relocate without sacrificing career opportunities. Business owners and executives who before the pandemic worried that remote work would spark shareholder and investor concerns learned their location was inconsequential so long as the company remained profitable. For many Americans, this meant a possibility to plant roots in states where they wanted to live rather than where their employers were located.

High-net-worth individuals often bear the brunt of state tax reform, particularly in high-tax jurisdictions, where policymakers continuously enact measures targeting affluent residents. These policies, characterized by higher tax rates and increased fiscal burdens, have spurred a mass exodus from high-tax states as individuals seek to safeguard their wealth and financial well-being.

Tax law is everchanging, but in recent years notable changes have been made by state tax legislation, specifically in several jurisdictions notorious for their high taxes, such as New Jersey, New York, Massachusetts, and California. In 2020, New Jersey raised its personal income tax by adjusting the thresholds for its top marginal bracket. Instead of applying the 10.75% rate to income over $5 million, that rate now kicks in at $1 million. In 2021, New York state increased its top tax rate from 8.82% to three additional tiers ranging from 9.65% to 10.9%. While it did not make the final cut, lawmakers supported yet another tax hike in the 2024–2025 budget proposal, which would have raised the top rate from 10.9% to 11.4%.

In 2023, Massachusetts implemented the controversial “millionaire’s tax,” officially known as the Fair Share Amendment, which narrowly passed in 2022. Those with taxable income over $1 million are subjected to an additional 4% surtax, which is projected to raise $2 billion per year. California recently increased to 1.1% its surtax on taxable income over $1 million, which, combined with its top marginal income tax rate of 13.3%, makes a staggering 14.4% combined rate for affected taxpayers, effective for tax year 2024.

Not only tax rates and brackets have been targeted. States have also introduced various forms of wealth tax legislation seeking to impose tax on an individual’s net worth in addition to their income. California proposed Assembly Bill 259, which sought to impose an annual 1% tax on individuals with a net worth of more than $50 million, and a 1.5% tax on those with a net worth over $1 billion. Although this bill and similar ones introduced by other states have faced opposition, they signify a growing trend among states exploring alternative revenue sources and attempting to address income and wealth inequality.

Data from the U.S. Census Bureau paints a clear picture of the impact of tax policies on population migration within the United States. States’ relentless pursuit of tax dollars from the affluent has led to a significant migration of wealth, exacerbating challenges related to revenue shortfalls and resident retention.

Establishing a new domicile

Due to this exodus, states are placing a heightened emphasis on residency audits. It is advisable that high-networth taxpayers seek guidance from experienced tax advisers once they have established an intent to move and before they have taken any action. This is especially true for taxpayers who are about to experience a large liquidity event. Domicile is subjective, and there are few absolute ways to guarantee treatment as a nonresident. Therefore, taxpayers need to take all appropriate steps before any large liquidity event occurs to ensure a successful outcome on audit.

Amid the intricacies involved with a domicile change and the various metrics reviewed across the states, there are three key steps: establishing a physical presence in the new state, forging personal and financial connections, and severing ties with the former domicile. Perhaps one of the most misunderstood concepts from a taxpayer’s perspective is that changing one’s domicile entails more than merely leaving; it requires a deliberate demonstration of the intent to make the new jurisdiction one’s permanent home.

As the ability to work remotely has risen, so too has the desire to live more nomadic lifestyles. Too often, advisers see cases where taxpayers insufficiently establish the second half of the transition, “sticking the landing,” i.e., establishing the new domicile. Absent an exception under the law to be treated as a nonresident, these taxpayers remain residents of their original state and subject to its taxation. There is nothing the best adviser can do to change the outcome here, and these cases often come with the additional unintended consequences of penalties associated with failure to file returns and open-ended statutes of limitation.

Another prevalent misunderstanding is that “six months and one day” is a suitable metric for proving the change in one’s domicile. That is because changing one’s domicile is often confused with statutory and presumptive residency laws around the country. However, domicile does not merely revolve around one’s time, although it is a key factor. In the simplest sense, domicile is the place an individual intends to have their permanent home — it has a range of sentiment and attachment not only to the physical property but to the community itself. This is distinct from statutory or presumptive residence tests, which define a taxpayer to be a tax resident regardless of their domicile state if they have a residence and spend some defined level of time within that state. While an individual can have multiple residences, they can have only one domicile. A taxpayer can be taxed on their worldwide income in two states: in one state as a domiciliary and in the other as a statutory/presumptive resident.

Undergoing a residency audit

Undergoing a residency audit can be complex, intimidating, and fraught with challenges for taxpayers. The process is often invasive and emotionally taxing, as auditors pick through personal records and question a taxpayer’s credibility. Auditors may request documentation related to the taxpayer’s residence, employment history, financial transactions, travel patterns, and social connections to substantiate their claims. Meticulous recordkeeping is indispensable. Contemporaneous and comprehensive documentation not only strengthens the taxpayer’s claim of domicile but also serves as crucial evidence in the event of an audit or dispute.

One of the most burdensome areas for taxpayers, both in preparation for and during an audit, is substantiating their physical presence. The process of constructing day counts can be time-consuming and tedious. Over the last decade, technology has helped to alleviate some of that stress — and a lot of errors — related to day-count tracking. By using historical cell site data, cellphone statements, and location-tracking phone applications, taxpayers can more effectively meet their burden of proof on audit. Use of these records has also reduced fees for audit defense, with advisers no longer needing to spend time combing through receipts, credit card statements, and electronic toll collection records to support one’s days. These records often contain transactions related to family members or household staff, causing auditors to call into question whether the records are reliable or, worse, using these “false positive” transactions to support the state’s case.

The best defense is a proactive one, because as long as taxpayers can freely relocate to lower-tax states, the wealth migration in this country will show no signs of stopping or reversing. With the exodus of their millionaire tax bases, states will continue to ramp up and aggressively pursue auditing for compliance. In the end, while states may experience revenue windfalls in the initial few years of these taxing programs, they run the risk that these short-sighted revenue grabs may lead to longer-term revenue decreases.

Editor Notes

Robert Venables, CPA, J.D., LL.M., is a tax partner with Cohen & Co. Ltd. in Fairlawn, Ohio.

For additional information about these items, contact Venables at rvenables@cohencpa.com.

Contributors are members of or associated with Cohen & Co. Ltd.