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In
January 1996 Robert Amen, now NOW president of International Paper in
Stamford, Conn., moved to Belgium as head of IP's European operations. His
wife and daughter followed that April, while his youngest son stayed
behind in New Canaan to finish high school. Relying on their company-paid
Ernst & Young accountants, the Amens filed their 1996 Connecticut
state income tax returns as part-year residents. But in April a judge
ruled they had never legally changed their domicile and owed Connecticut
tax on all their 1996 income.
Some of the evidence against them: They had
leased out their Connecticut home instead of selling it; they had switched
their country club membership to inactive instead of resigning; and Mrs.
Amen's mother lived in Connecticut.
If you're planning to move or if you have homes
in more than one state, watch out. States are getting ever more creative
about collecting income tax from people who have any ties to their
territory. Even states without income taxes are getting into the act, with
sales- and use-tax audits (see box, p. 84). Upping the stakes in the
residency wars: Many states' estate taxes, invisible and painless until a
2001 change in federal law, have since become real burdens because the
federal estate tax credit that used to be available to offset them is now
gone.
What makes residency particularly tricky is that
each state has its own set of rules. Some simply count the days you've
spent there. Spend at least 183 days in Michigan in a year and you're a
resident for tax purposes--although not necessarily for the purposes of
getting cheaper in-state tuition at the University of Michigan. Other
states look at days, but also try to determine where you intend to make
your permanent home. Connecticut divines intent from 28 factors ranging
from where you register your dog to where you pray.
The result is that you could end up paying tax on
the same income to two states. New York tax lawyer Mark Klein has a client
who sold stock and found California, Connecticut and New York all wanted a
cut. The man has homes in all three states and arguably meets all three
states' residency tests. His wife, kids and roots are in Connecticut. But
he spent more than 183 days in New York and was assigned to work
indefinitely on a project in California. Like a normal commuter working in
New York and living in Connecticut, Klein's client can claim a Connecticut
tax credit for the New York taxes he paid on his wages during the days he
actually worked in New York. But Connecticut won't cut him a break for the
New York or California taxes on his gains.
Even if you don't end up paying double tax,
residency audits can be brutal. Your credit card charges, telephone calls
and where you keep your underwear could all be scrutinized and might
become a matter of public record. Inventor Gilbert Hyatt claims a
California auditor went through his trash and spread inaccurate
information about him as she sought to prove he owed taxes on $40 million
in patent licensing fees. Hyatt insists he moved to Nevada (which has no
income tax) before getting the fees and is suing California in a Nevada
court for invasion of privacy. Last year the U.S. Supreme Court ruled that
Hyatt could proceed with his privacy suit in Nevada. (The outcome could
impact the nosiness of tax auditors nationwide.) Meanwhile his tax case in
California is on hold.
Here's how to leave a state--and its taxes--behind.Just
moving out of your old state is not enough; you need to show you've cut
your old roots Planted new ones elsewhere. After graduating from the
University of Alabama in 2002, Tara Kolstad took a job on a cruise line
operating out of Seattle. She sublet her Birmingham apartment, gave her
car to her brother and bought a one-way ticket to Seattle. In July,
however, an Alabama administrative law judge ruled that Kolstad hadn't
permanently moved to Seattle and so was still legally domiciled in Alabama
in 2003 and owed it tax. He noted she hadn't rented an apartment in
Seattle for the cruise's off-season. She testified she couldn't afford one
and instead stayed with friends in Alabama, Arizona, Tennessee and China.
At least the judge acknowledged the case was a "close call" and
erased penalties.
A Minnesota Tax Court judge was harsher on
retired physician Roger Dreyling, who filed as a nonresident, claiming he
was domiciled in state-income-tax-free Alaska.
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After retiring, he lived
part-time in Alaska, fishing, hunting and working briefly as a tribal
doctor. He got an Alaska medical license but didn't give up his Minnesota
license. He registered to vote in Alaska but didn't vote.
The
judge concluded in February that Dreyling merely "went through the
motions of trying to establish a domicile [in Alaska] to avoid his
Minnesota tax liability" and that the center of his family, business
and social life remained in Minnesota. The judge upheld a 50% fraud
penalty and a 20% underpayment penalty because, he said, Dreyling had
refused to hand over banking records and hadn't consulted a tax pro on the
residency issue. Dreyling, who says he did consult his CPA, has appealed
to the Minnesota Supreme Court.
It used to be you could just change your
driver's license and register to vote in your new state and the domicile
fairy spread her dust," says Klein. "Now auditors say anyone can
fill out a piece of paper; you have to really change your lifestyle to
overcome the burden of proving residency. "That means you
shouldn't double dip. Physician Dreyling, for example, continued to claim
the "homestead" property tax break on the Minnesota house where
his wife remained. And while he got an Alaska driver's license, he kept
his "surrendered" Minnesota license and used it to get cheaper
resident fishing and hunting licenses there.
Another
inconsistency: A business owner hands over control to his kids or partners
and moves out of state. But on his federal return he continues to treat
the business as if he's an active--not a passive--investor in it. (There's
a benefit to that since losses and credits from passive activities can't
be deducted against nonpassive income such as interest or dividends.) No,
you don't have to give up all your business ties in your old state, but
it's a tricky issue and you need professional advice. One man who told
auditors he was "deeply, deeply involved" in the operation of a
New York business and felt that his involvement was "vital to the
health of the company" had to pay for it as a New York resident.
Auditors will compare your asserted new domicile to your other home or
homes. If you trade in your five-bedroom New York house for a four-bedroom
house in Florida and a New York City studio, that's a better case for
Florida residency than if you keep your five-bedroom house in New York and
rent a small condo in Florida.
If you want to keep a home in your old state,
consider selling your old property and buying a new, smaller place. True,
there are transaction costs. But remember, if you want to claim the
$500,000-per-couple federal capital gains exclusion on the sale of your
old home, you'd have to sell soon anyway. To qualify for the break, the
property must have been claimed as your primary residence for at least two
of the five years before the sale.
Make sure your new home fits your circumstances.
After separating from his wife, New York tax adviser Craig Knight moved
out of their New Jersey house and claimed his childhood bedroom in his
parents' New Jersey home as his domicile. New York auditors didn't buy it.
They decided he lived at a New York corporate apartment near his office,
where he received personal bank statements. In June a New York Division of
Tax Appeals administrative law judge upheld the auditors; Knight is now
appealing a $550,000 back tax bill.
Even if you keep your big old place, move your
valuables--your art, your jewelry and the insurance on them--to your new
home. These days New York even expects you to take your fur coat down to
Florida; earlier audit guidelines allowed you to keep a fur up north
without counting it as evidence that New York was still your real home. H.
Anthony Ittleson, the grandson of the founder of CIT Financial, moved to
South Carolina in December 1996 but left a Modigliani behind in his New
York City co-op, until he sold both the co-op and the painting the
following spring. In August the New York tax appeals tribunal ruled that
the painting, which had hung in the co-op since 1986, was New York
property and he was subject to 6.85% tax (plus interest) on his $7 million
gain. Ittleson contended he kept his painting in New York for temporary
storage and sale--an argument that would have worked had he always lived
in South Carolina and merely sent the painting to Sotheby's for auction.
Count Your Days. Most states presume
you'll spend more time at home than any other place. Say you spent 170
days in New York. That's under the 183 that would automatically make you a
New York resident. But if you spent only 90 days in Florida and the rest
traveling, New York won't necessarily concede that you live in Florida. If
you need to connect to an international flight through , don't leave the
terminal for lunch, or New York will count it as a day in the Big Apple.
And watch where you gas up: When a Connecticut man drove to New York for
cheaper gas, New York counted it as a day.
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