The Significant Tax Consequences of Moving out of New York

One potential fallout from the Covid-19 pandemic, especially as many employees have shifted to remote work permanently, is that federal and state tax authorities may increasingly scrutinize a person’s claimed tax residency.

Whether enticed by the flexibility of remote work or concerned about living in populated areas, many people have picked up and moved elsewhere because of the pandemic. New York, a state among the hardest hit by Covid-19, experienced a large exodus of people relocating to other states and, in some cases, even outside of the United States.

What they may have overlooked (or ignored) in relinquishing their state residency are the special rules that apply when determining their true tax residency. And some who renounced their U.S. citizenship for immigration-law purposes may not have also renounced their U.S. citizenship for tax purposes by filing Form 8854, Initial and Annual Expatriation Statement. These people may be surprised to find that they are liable for a $10,000 penalty. They may face additional, onerous tax consequences as a result of being classified as a “covered expatriate.”

Against this background, it is important to revisit and understand the rules that apply to determining a person’s tax residency at the state and federal level.

Relinquishing New York State Residency

The New York State Department of Taxation and Finance (NYSDTF) has been more aggressive than usual with respect to residency audits. Historically, the NYSDTF focused enforcement efforts on taxpayers earning at least $1 million per year in income. But the NYSDTF is now casting a wider net, instigating residency audits for individuals earning as little as $100,000 per year who claim to have left New York state during the Covid-19 pandemic. Those who reported that they lived in New York state for only part of the year, or who allocated less income to New York state than in prior years, are particularly vulnerable to these residency audits.

The classification of an individual as a resident or a nonresident for tax purposes is significant because New York state taxes its residents on all of their income, regardless of where that income is earned, and generally allows a credit for income earned outside of New York. By contrast, New York taxes nonresidents only on income that is sourced in New York state.

As counterintuitive as it seems, simply moving to another state is not enough to change one’s New York state residency for tax purposes. New York tax law defines a resident as any individual who:

(1) Is domiciled in New York; or

(2) Is not domiciled in New York state, but who maintains a permanent place of abode in New York state and spends 184 days or more in the state, unless such individual is in active service in the armed forces.

This raises the question: What does it mean to be domiciled in New York? New York tax regulations define the term “domicile” as “the place which an individual intends to be such individual’s permanent home—the place to which such individual intends to return whenever such individual may be absent.” A person can have multiple residences, but only one domicile.

The regulations go on to provide that an established domicile will continue until the individual moves to a new location with the bona fide intention of making his or her fixed and permanent home there. Importantly, especially at audit, the burden of proving intention is on the person asserting a change of domicile. That burden is extremely difficult to satisfy, as evidenced in the 2021 determination by the State of New York’s Division of Tax Appeals in In the Matter of the Petition of Thomas A. Boniface and Jean Boniface.

In Boniface, the state of New York’s Division of Tax Appeals held that a couple with a Florida home was nevertheless domiciled in New York for tax purposes. The tribunal found that the taxpayers had not clearly and convincingly proven that they relinquished their New York domicile and acquired a Florida domicile.

The opinion states, “While petitioners did take actions aimed at establishing Florida as their domicile, including purchasing a home in Florida, acquiring Florida driver’s licenses, and completing a Florida homestead exemption application, these formal declarations must be considered in conjunction with the informal acts which show an individual’s ‘general habit of life.’” The judge noted that although the standard is subjective, the courts and tribunal have consistently looked at certain objective criteria to determine whether a taxpayer’s general habits of living demonstrate a change of domicile. Among the factors that have been considered when determining a taxpayer’s domicile are:

(1) the retention of a permanent place of abode in New York;

(2) the location of business activity;

(3) the location of family ties; and

(4) the location of social and community ties.

Applying these factors, the tribunal found that: (1) where taxpayers had two residences, one in New York and one in Florida, the length of time spent at each location weighed into the determination that petitioners were domiciled in New York rather than in Florida because petitioners spent more time in New York than in Florida in the year at issue; (2) when considering business ties to New York, the only evidence in the record showed that Mr. Boniface had an ownership interest in several organizations in New York (which the tribunal considered even though they were passive interests); and (3) the taxpayers offered little credible evidence as to their social ties in New York and in Florida since they only submitted self-serving letters asserting that they had children and grandchildren in New York but several family members in Florida. As such, the tribunal held that the taxpayers did not meet the burden of proof to demonstrate that they had established a new domicile in Florida and were not domiciled in New York. The taxpayers were therefore taxed as New York residents for the year at issue.

As Boniface shows, while “domicile” turns on subjective intent, to determine that intent, judges scrutinize taxpayer actions. In addition to the four factors mentioned in the Boniface opinion, New York auditors are instructed to inquire about the location of items that hold significant sentimental value to the taxpayer. This inquiry, known as the “near and dear factor,” can be quite intrusive because of the personal nature of “near and dear” items such as family heirlooms and pets.

After analyzing the five primary factors, an auditor should consider “other” factors, including the location of voter registration, driver’s licenses, and addresses on bank and credit card accounts. In sum, taxpayers should carefully consider whether their actions actually support a finding of intent to change their New York domicile.

Taxpayers who intend to permanently change their domicile should take affirmative steps to relinquish ties to New York state and to have the supporting documentation to prove domicile if audited by the NYSDTF. Such affirmative steps might include, for example, establishing a primary residence outside of New York state and spending more time at that non–New York residence than at any New York residence. To help show that the primary residence is not in New York, taxpayers should update the address they use for bills, legal documents, and government correspondence to the out-of-state address.

Additionally, taxpayers should take steps to establish roots in their new community such as obtaining a driver’s license, registering to vote, registering any vehicles in the new state, and finding doctors, dentists, and banks in the new state. Items that are “near and dear” (expensive or emotionally significant) should also be moved to the new residence. And, although it may be difficult based on the taxpayer’s circumstances, a taxpayer hoping to escape a residency audit unscathed should consider spending more time with family at the new residence, and limit any ongoing involvement with businesses located in New York.

Ultimately, the more affirmative steps that taxpayers take to relinquish ties to New York state and establish a new primary residence elsewhere, the better their chance of success in a residency audit.

Even if taxpayers are not determined to be domiciled in New York state, they can be taxed as New York state residents if they own or lease a permanent place of abode in New York and are present in the state for 184 days or more. A permanent place of abode is a residence that the taxpayer maintains, whether they own it or not, and that is suitable for year-round use. Maintaining a place of abode usually means the taxpayer owns or rents the residence, but also includes situations in which the taxpayer makes contributions to a household through money, services, or otherwise.

Additionally, if an employer maintains a place of abode for its employee that is suitable for year-round use, and it is maintained primarily for the taxpayer’s use, then it is considered the taxpayer’s permanent place of abode. To avoid New York residency, taxpayers with a permanent place of abode in New York must make sure they are not in the state for 184 days or more during the calendar year (with partial days counting as full days).

Taxpayers who intend to re-establish domicile outside of New York are susceptible to scrutiny by state tax authorities. And because it is taxpayers’ responsibility to prove nonresidency for income tax purposes, anyone deciding to move out of New York should keep records of the time spent inside and outside the state in a given year. A residency auditor will typically ask for a marked-up calendar, airline tickets, credit card statements and receipts, and cell phone records to determine the taxpayer’s location on each day of the year under audit. Classification as a New York state resident can be costly, so taxpayers intending to re-establish domicile should take precautionary steps to avoid that classification.

Renouncing U.S. Citizenship

Taxpayers who seek to leave the United States altogether must also be wary of the tax consequences of their actions. The IRS recently reported that U.S. citizens are increasingly renouncing their U.S. citizenship. However, many taxpayers who renounce their citizenship for immigration purposes fail to also do so for tax purposes by filing Form 8854. Taxpayers who renounce their citizenship for immigration purposes without filing Form 8854 may be taxed as “covered expatriates.” Taxpayers who renounce their U.S. citizenship and long-term residents who end their U.S. resident status may trigger U.S. income tax, including the expatriation tax or “exit tax” under §877A of the Internal Revenue Code (IRC).

The Heroes Earnings Assistance and Relief Tax Act of 2008 (HEART Act) added IRC §877A, effective for individuals who expatriate on or after June 17, 2008. Under IRC §877A(a)(1), all of a covered taxpayer’s worldwide assets are treated as being sold at fair market value the day before the taxpayer’s expatriation. The exit tax is an income tax (at ordinary income tax rates) that applies to unrealized gain from that deemed sale if the deemed gain exceeds an inflation-adjusted safe harbor, which was $737,000 for 2020. Additionally, IRC §877A applies only to covered expatriates who meet any one of three tests:

(1) The Net Worth Test: Expatriates having a net worth of $2 million or more on the date of expatriation, considering all assets worldwide;

(2) The Average Annual Income Tax Liability Test: Expatriates earning an average annual net income tax for the five years ending before the date of expatriation of more than a specified amount, adjusted for inflation ($171,000 for 2020); and

(3) Failure to Certify Tax Compliance: Expatriates who fail to certify on Form 8854 satisfaction of federal tax compliance to the Secretary of Treasury for the five preceding taxable years.

Section 877A of the IRC requires all U.S. citizens who renounce their citizenship to file Form 8854, in order to certify compliance with the U.S. tax laws for the five years preceding the expatriation. As such, Section 877A can cause expatriating individuals who fall below the statutory thresholds to be deemed covered expatriates if they fail to file a timely Form 8854. Under I.R.C. §6039G(c), an individual who must file Form 8854 for any tax year, and who fails to do so on or before the date the form is required to be filed, or who fails to include all of the required information or includes incorrect information, must pay a $10,000 penalty unless it is shown that the failure is due to reasonable cause and not due to willful neglect.

Moreover, failure to file Form 8854 makes individuals who renounced their U.S. citizenship prior to June 17, 2008, indefinitely liable for U.S. income tax. Individuals who expatriated prior to June 17, 2008, but after June 3, 2004, continue to be taxed as U.S. citizens or residents until they file the required Form 8854 with the IRS under IRC §877. Such individuals can be subject to tax under IRC §877 for the 10-year period that commences on the date on which they file Form 8854. For these reasons, taxpayers should not overlook filing Form 8854.

Ultimately, failing to file the Form 8854 will cause a taxpayer to be treated as a covered expatriate under IRC §877A. Recognizing widespread noncompliance with the obligation to file Form 8854, in September 2019 the IRS announced procedures for certain persons who have relinquished, or intend to relinquish, their U.S. citizenship and who wish to come into compliance with their U.S. income tax and reporting obligations and avoid being taxed as a “covered expatriate” under I.R.C. §877A. Importantly, these relief procedures are available only to citizens who:

(1) Relinquished U.S. citizenship after March 18, 2010;

(2) Have no filing history as a U.S. citizen or resident;

(3) Did not exceed an average annual net income tax as established by the threshold in IRC §877(a)(2)(A) for the period of five taxable years ending before the date of the loss of U.S. citizenship;

(4) Have a net worth that is less than $2,000,000 at the time of expatriation and at the time of making submission under the procedures;

(5) Have an aggregate total tax liability of $25,000 or less for the five tax years preceding expatriation and in the year of expatriation; and

(6) Agree to complete and file with their submission all required federal tax returns for the six tax years at issue, including all required schedules and information.

An otherwise covered expatriate who submits required documentation set forth by the IRS and meets the requirements of the above procedures will not be a covered expatriate under IRC §877A and will not be liable for any unpaid taxes and penalties. Generally, if a taxpayer is not eligible to make a submission under these procedures yet still makes a submission, the IRS will process the returns using normal processing procedures and the taxpayer will be liable for all taxes, penalties, additions to tax, and interest associated with the submission.

Significantly, if a taxpayer is considered a “covered expatriate” for failure to file Form 8854 alone, the taxpayer may late-file Form 8854, along with a statement of reasonable cause explaining all facts and circumstances relating to the late filing. If the statement of reasonable cause is accepted, the taxpayer will satisfy the tax compliance certification requirement and avoid “covered expatriate” status. As such, filing Form 8854, even if late, will allow a taxpayer with reasonable cause for the late filing to come into compliance with the internal revenue laws and avoid being taxed as a covered expatriate under IRC §877A.

Even if an individual successfully renounces U.S. citizenship or U.S. resident status, an individual who is neither a U.S. citizen nor a permanent resident may generally still be considered a U.S. tax resident under the substantial presence test, which looks to the number of days an individual spends in the United States in a given year. The IRS considers an individual a U.S. resident if physically present in the United States on at least 31 days of the current year and 183 days during a specified three-year period.

The three-year period consists of the current year and the prior two years. The 183-day rule includes all the days present in the current year, one-third of the days present in year two, and one-sixth of the days present in year three. If the total number of days over the three-year period is 183 days, and the individual was present in the U.S. for at least 31 days of the current year, then the individual will be treated as a U.S. resident. Exceptions to the foregoing rules may apply for individuals who maintained a closer connection to a foreign country than to the United States.

Conclusion

In sum, the tax consequences associated with leaving New York state or the United States should not be overlooked. Taxpayers changing New York state residency should make sure they are truly changing their domicile according to the objective factors considered by the New York state tax authorities, or else make sure they do not spend 184 days or more in the state if they own a permanent place of abode in New York State. Those individuals renouncing U.S. citizenship should consider whether they owe an exit tax, file Form 8854, and make sure they are compliant with the U.S. tax laws before renouncing U.S. citizenship. The failure to comply with these technicalities can lead to an audit and costly impositions of tax.

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Daniela Calabro, an associate at McCarter & English, handles federal and state tax matters regarding mergers, acquisitions, and restructurings, as well as state and federal tax controversies. Lawrence A. Sannicandro, a partner at the firm, focuses his practice on federal and state tax controversies. Jamie M. Zug is an associate in the firm’s tax & employee benefits practice. They can be reached at dcalabro@mccarter.com, lsannicandro@mccarter.com, and jzug@mccarter.com, respectively.

From: The New York Law Journal