Just When They Thought I Was Out, They Pull Me Back In: Changing New York Residency and Domicile
Due to recent changes in the New York State income tax, which makes New York the most onerous income tax jurisdiction in the nation, many New York residents have attempted to change their state of domicile to ensure their income not effectively connected to New York will escape New York taxation. However, for all the obvious reasons, New York (and every other State in the country) is incentivized to keep high-income earners on the hook for state taxes on as much income as possible, so New York frequently audits high-income earners who claim they are no longer New York residents. Before attempting to change domicile from New York to a different state, one must consider all the factors a New York auditor might analyze when evaluating whether a change of domicile was truly complete and effective.
How Does New York State Determine Residency?
There are two tests under the New York State Tax Law to determine an individual’s residency:
(1) the statutory residence test, OR
(2) the domicile test.
If a taxpayer falls under either test for the specific years under review, he is considered a New York resident for income tax purposes. If he does not, they he has changed his residency to a location outside of New York. This article will first outline the statutory test, which is the simpler test. The domicile test, however, is less mechanical and more nuanced than the statutory residence test.
Statutory Residence Test
The statutory residence test provides a (primarily) objective measure to determine New York State residency. It tests:
(1) whether a taxpayer maintains a permanent place of abode in New York (defined as a dwelling place maintained by the taxpayer as a residence for himself or herself); and
(2) whether a taxpayer spends more than 183 days of a given year in New York.
To be clear, New York defines a “day” as any time spent in New York during a particular day except for traveling through the state to get to an airport (or having a layover in a New York airport) and any days spent in a New York hospital. Essentially, where a taxpayer is not considered a domiciliary of New York but maintains a permanent place of abode for himself in the state and spends more than 183 days of the taxable year in New York, the taxpayer may fall into this category for New York State residency purposes.
According to the regulations, an individual who maintains a permanent place of abode in New York State must keep such abode “for substantially all of the taxable year.” Auditors define “substantial” to mean a period exceeding 11 months. For example, if a taxpayer disposes of their New York permanent place of abode on October 30, the taxpayer would not meet the statutory residence test (despite spending over 183 days in New York) because the individual did not maintain their permanent place of abode in New York for more than 11 months. Thus, the individual would not be considered a New York resident under this test for any part of the year.
Provided that a taxpayer resides outside of New York for at least six months, the taxpayer will not meet the statutory test for residence, and New York will only be able to argue that he was a resident under the domicile test. For both the statutory residence and domicile tests, any day where a taxpayer spends any time in New York (other than passing through New York to reach another state) will be considered a full day in the state.
The Domicile Test
The New York State Department of Taxation and Finance (the “Department”) provided their “Nonresident Audit Guidelines” in 2014 and defined domicile as the place “to which the individual intends to return whenever absent.” The following are the primary factors an auditor should weigh when analyzing whether an individual is domiciled in New York: (1) Home; (2) Active Business Involvement; (3) Time; (4) Items Near and Dear (to the heart) and; (5) Family Connection.
The Guidelines stress that none of these primary factors should be considered, by themselves, as a “stand-alone” indicator of domicile. The Department will weigh and balance each element against the others based on the individual’s specific facts and circumstances.
An auditor’s analysis of one’s “home” will consider the person’s individual use and maintenance of his New York residence compared to his non-New York residence. When a taxpayer buys a new home in a different state and maintains two or more residences (with at least one remaining in New York), this factor becomes harder to analyze. In unclear situations, an auditor will compare the use of multiple homes under the following factors: (a) size of residence; (b) value of residence; (c) nature of use; and (d) other aspects of a home.
New York courts have held that “to create a change of domicile, both the intention to make a new location a fixed and permanent home and actual residence at that location… must be present” (Matter of Minsky v. Tully, 78 AD2d 955). The intention to change domiciles occurs when “the place of habitation is the permanent home of a person, with the range of sentiment, feeling and permanent association with it.” (Matter of Bodfish v. Gallman, 50 AD2d 457, quoting Matter of Bourne, 181 Misc. 238). While the simple act of putting a home up for sale might be a helpful indication that a taxpayer would like to change his domicile, the degree of effort made by the taxpayer to sell his home provides the best indication (or not, as the case may be) of intention to change domicile.
One thing to bear in mind for those purchasing new homes outside of New York but keeping a New York residence is qualifying for Section 121 of the Internal Revenue Code of 1986, as amended (the “IRC”). This section permits taxpayers to exclude the gain on the sale of a primary personal residence up to $250,000 ($500,000 if married filing jointly). The IRC defines primary residence as the home a taxpayer uses a majority of the time during the year; however, this does not necessarily mean a taxpayer changes domicile under New York law (i.e., one can attain a domicile outside of New York while still satisfying the primary residency qualification of Section 121). Domicile incorporates the critical element of intent, while personal residence under Section 121 generally requires living in a home for more than 183 days (akin to New York State’s rules for statutory residency).
Furthermore, under Section 121, a taxpayer must use his property as a principal residence in at least two of the five years preceding the date of sale. Thus, if a taxpayer maintains his former primary residence in New York and eventually wants to use Section 121 when he sells his New York residence, he must sell that New York home within three years after changing primary residence to a different state.
Auditors will also consider whether a taxpayer claims a mortgage interest deduction on their federal tax return for any of the years in question, since this deduction is limited to a taxpayer’s principal residence. It follows then that the taxpayer cannot have it both ways and include the year he changed domicile as a qualifying year for the Section 121 exclusion. Ultimately, each taxpayer affected by these factors must analyze their particular facts and circumstances and carefully plan their whereabouts and activity to prevent adverse outcomes.
(2) Active Business Involvement
Taxpayers who are considerably involved—or have substantial investment—in a New York trade or business, occupation or profession will have difficulty with this factor under audit and should plan accordingly to navigate it. Even if a taxpayer is not physically present in New York, he can still actively participate in the business through phone calls, video-conference calls, and emails.
For example, in Matter of Herbert L. Kartiganer et al., 194 AD2d 879, the taxpayer moved to Florida but admitted that he “retained a significant proprietary interest in his engineering firm and continued to play an active role in its day-to-day operations.” The administrative law judge (ALJ) noted that the work performed in Florida was on behalf of the New York employer. The taxpayer’s involvement was not limited to the periods in which he was in New York and included any work performed in Florida (for the company). Thus, the ALJ concluded these business interests were the most persuasive in finding that the taxpayer did not change their domicile to Florida in the years under audit.
Taxpayers and business owners who intend to change domiciles should also consider the passive activity loss rules they might otherwise be trying to avoid. When a taxpayer submits documentation with his federal income tax return to demonstrate he materially participated in a New York activity, a New York auditor might use this information to validate a position that the taxpayer had significant business ties in the year under audit. Thus, this inference of active involvement in a New York trade or business for that year will be weighed in favor of maintaining New York as the taxpayer’s domicile.
When the head of a closely held business, or family business, plans to retire and change residency out of New York, he should formalize plans to pass the reins to a successor. An auditor will assess the extent to which the individual supervises, manages, and maintains general control of the business’s daily operations, and even remote participation can contribute to a finding that a taxpayer has not changed domicile.
This factor requires an analysis of where and how an individual spends time during the year by comparing the time spent in New York versus time spent in other locations. As previously noted, many people follow the six-month-and-a-day rule; however, the more time a taxpayer can spend in his claimed domicile, the better off he will be when an auditor considers this factor.
Courts and auditors focus on a taxpayer’s living patterns to determine whether a new location has become their domicile. For instance, substantially more weight will be given to an individual who buys new residences in Florida and New York, and only visits New York in the summer months. Auditors should not assess these seasonal visits negatively for changing domiciles because it is entirely consistent with the taxpayer’s new living pattern. By comparison, it is less persuasive when an individual spends six months out of the year in Florida (while still being a New York domiciliary) for many taxable years and then spends seven months in Florida for a particular year. This insignificant change in living pattern does not establish robust evidence that the taxpayer changed his domicile to Florida.
(4) Items Near and Dear (To Taxpayers’ Heart)
In effect, this primary factor attempts to determine the location of items with significant sentimental value (e.g., family heirlooms, works of art, collection of books, personal items that enhance one’s quality of life). The guidelines stress the difference between sentimental significance and monetary value. Of course, sentimental significance is highly subjective. Still, auditors attempt to determine whether moving certain items is probative in determining a taxpayer’s intent to change domiciles. Additionally, when valuable items have been appraised and insured, the mere existence of such measures is not necessarily indicative that these possessions should follow the taxpayer to their new domicile. While an auditor might analyze sentimental items (e.g., furniture, carpets, furs, etc.) left in New York, they will also consider the extent that those items stayed in New York because they do not fit (e.g., aesthetically, practically, etc.) in the new domicile state.
(5) Family Connection
Given its intrusive nature, the final factor, “Family Connection,” is only taken under consideration when a domiciliary determination from the first four primary factors fails to produce intent by clear and convincing evidence. Moreover, it is generally limited to the taxpayer’s immediate family (i.e., spouse or partner and any minor children). An essential aspect to this factor is the school location(s) for the taxpayer’s minor children. For example, in Matter of Donald C. Smith & Carol A. Groh, DTA Nos. 810532 & 813342, the Tribunal supported the conclusion that the couple was domiciled in New York (the couple claimed New Jersey) because their five and nine-year-old children attended school in New York City for the entire audit period, and the school recorded a New York City address for the family during that period. Specifically, the Guidelines relate to the time factor and focus on the taxpayer’s living patterns. The Guidelines go further and state “the family connection can help determine the domicile of an individual when it is the bond that draws an individual back to a location whenever absent and encompasses his habit of life.”
(6) Other Factors (Not Typically Considered)
If an analysis using the above factors proves indeterminate, the New York State auditors will turn to “other” factors. These factors include the locale of the taxpayer’s:
· Driver’s license
· Voter registration
· Vehicle registration
· Bank accounts
· Credit card records
· Houses of worship
· Country club membership
· Library card
Once again, while none of these factors have significant clout in and of themselves, they might be used to influence a domicile analysis toward or against New York State residency in case the primary factors do not provide a clear-cut resolution.
When considering a change of residency out of New York State, it is essential to view all the above factors, plan accordingly and document every detail of the change. Falcon Rappaport & Berkman PLLC can advise about planning and organizing a change of domicile and maintaining coherent, organized records in case of audit.
DISCLAIMER: This summary is not legal advice and does not create any attorney-client relationship. This summary does not provide a definitive legal opinion for any factual situation. Before the firm can provide legal advice or opinion to any person or entity, the specific facts at issue must be reviewed by the firm. Before an attorney-client relationship is formed, the firm must have a signed engagement letter with a client setting forth the Firm’s scope and terms of representation. The information contained herein is based upon the law at the time of publication.