The Intrusive Residency Audit

December 16, 2019

By Jenifer Pento

Think you’re ready to flee a high tax state? Planning and preparation are key so you won’t be blindsided by increasing residency audits.  

Residents in high-tax states are leaving for states with no personal income tax, due in part to the federal Tax Cuts and Jobs Act and its $10,000 cap on state and local tax deductions. These attractive states include: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. Nonresidents are taxed only on the portion of income sourced to the state, while residents are taxed on all income. High income earners changing domicile face a high risk of being audited. A good reason for this is simply that these residency audits generate a tremendous amount of income to the states.

A residency audit is an intrusive type of audit for individual taxpayers. The burden of proof remains on the taxpayer. As defined by “clear and convincing,” the evidence must be highly and substantially more likely to be true than untrue. You can have many residences, but you can have only one domicile; in other words, one place that you intend to make your permanent home.

Most states generally have two tests to assess residency.  The first focus will be the domicile test and then the auditors will look to the statutory residency test:

  • Statutory Residency/183 day test: This test looks at where you maintain a permanent place of abode and if you spent more than 183 days there during the year. High-tech tools being utilized now can track the number of days a taxpayer is present in a state. Auditors may also search EZ Pass records, credit card statements, flight occupancy records, swipe cards, doctor’s records, social media feeds and cell phone tracking records. Any part of a day is considered a “day.” The tax department will use this to its advantage and subpoena many of these records.
  • Domicile Test: This is a more subjective test, and when you don’t sell but retain the former home, and move to a new domicile, the test generally considers five key comparative aspects that determine your domicile: home and its use and maintenance compared to the new home in another state, where your business is located, time out of state, location of items with sentimental value and location of close family members. Since these factors may not always be clear, this can be a subjective determination, and the state can more aggressively target these areas.

To expand, there are other factors which an auditor may look at to determine domicile:

  • The physical location of the safe deposit boxes used for family records and valuables;
  • Location of auto, boat, and airplane registrations as well as personal driver's or operator's license;
  • Indication as to where you are registered to vote; and
  • The citation in wills, testaments and other legal documents, such as health insurance, that a particular location is to be considered your place of domicile

Winning a residency audit is not an easy victory. The audit can drag on for months or even years, but there are steps you can take to avoid this situation and there are ways to be prepared if a state income tax auditor comes looking to collect.

About Jenifer Pento

Jenifer Pento is a Senior Accountant in the Private Business Service Group providing public and private accounting and tax compliance services to privately held businesses, individuals, estates, trusts and private foundations.