Thinking of moving to a tax-advantaged state? Take these steps

It’s not unusual for wealthy taxpayers to relocate from high-tax states to low-tax states. There’s evidence in population trends: Texas and Florida — neither of which have a state income tax — were the states with the biggest population increases from 2020 to 2021, according to the latest U.S. Census Bureau data. Much of that growth is coming at the expense of higher-tax states such as California, New York and Illinois.

These days, it is very common for wealthy families to own residences in more than one state, making relocation even easier. However, the reality is that any state that does have an income tax, and in which an individual owns a home, will have a vested interest in asserting that the residence in their state is that person’s domicile.

In practical terms, having domicile in a state means that state can impose its respective income tax on all the income reflected on the individual’s federal income tax return, regardless of the source of that income. This is one of the principal reasons that many people consider relocating.

Potentially adding to the trend of such moves is a wave of states’ efforts to find new ways to tax the rich. These bills range from imposing a “wealth tax” on the intrinsic gains from stocks and securities and creating special income tax brackets targeting the rich to reducing exemptions on inheritance taxes.

But before you call the moving van, understand that state taxation, including state income tax as well as state estate and inheritance taxes and potential wealth taxes, is only one factor to consider as you assess changing your domicile.

Other areas to consider include rules that govern asset protection, trust administration, trustee selection and estate administration. Some who redomicile to a state with no income tax may find that they are paying the state in other ways, such as higher inheritance, property and/or fuel taxes.

That’s why the state you choose as your domicile is such an important decision. That decision is even more challenging considering that states often have different rules defining what they consider domicile.

Some use so-called “bright line” tests; for instance, a certain number of days in and out of the state. Others use a “preponderance of evidence” approach that considers where you vote, where your driver’s license is issued, where your advisors are located and numerous other factors.

Since I personally redomiciled from Minnesota to Florida and have assisted many of my clients in doing the same, I am often asked about “the right way” to do it.

The most important thing is to ensure, upon inspection, that you can demonstrate that the move is real and not just on paper. Simply getting a driver’s license or registering to vote in the new state will likely not be enough. Not surprisingly, states with high income taxes do not like to lose tax revenue from wealthy families and will very often audit taxpayers who say they’ve redomiciled.

When I have a client who is serious about changing domiciles, we go through a checklist of the things they should do to prove they have severed the connection to their former state of residence. The more evidence you can produce to show that you are domiciled in, and not just a resident of, your new state, the better off you’ll be, even if it only seems to be supporting evidence. Items to consider include:

• Buy or lease property. The first step in redomiciling should be to purchase or rent a residential home in the new domicile state. If the residence is a rental, the term of your lease should be for at least one year.

• Log your travels. Make certain to spend at least 183 days per year outside your old home state. Limit return trips to your prior home and keep a record of where you spend your time when you are not in the new state.

• Change your license and registration. Obtain a new driver’s license and register any automobiles or boats in the new state. If you keep any licenses from your prior home, make sure they reflect that you are a nonresident.

• Register to vote. Register to vote in your new state. Write to the registrar of voters at your prior home, too. Mention your change of domicile and ask that you be removed from voting lists.

• File a declaration of domicile. In some states, like Florida, it is possible and advisable to file a declaration of domicile in which you attest to the fact, under penalty of perjury, that your domicile is the new state.

• Move bank accounts and safe deposit boxes. It’s hard to make the case for changing domiciles if all your financial holdings are in the old state.

• Declare a change of address. Send notification of your change of address to family, friends, business associates, professional organizations, credit card companies, brokers, insurance companies and magazine subscription offices.

• Establish a new home base. When you travel, try to return to the new state. When you make large purchases, make them in the new state. Keep your family heirlooms, furniture and keepsakes in the new state.

• Change legal documents to reflect residency. Upon redomiciling, you must update your will and trust and estate documents. Make sure that these documents do not identify you as a resident of another state. Also make sure your federal tax returns indicate your new address.

• Develop local affiliations. Join local organizations in the new state, such as clubs and religious groups, and participate in local charitable activities.

• If it exists, apply for a homestead exemption. In some states, such as Florida, a homestead exemption will be counted against your real estate taxes.

Each person has a unique tax situation. Please consult with your financial and tax professionals when considering a change in domicile.

— By Paul J. Ayotte, founding partner and client advisor at Fidelis Capital