November 15, 2023

The Migration of High-Net-Worth Individuals to Low-Income Tax Jurisdictions

By Jo Anna M. Fellon, CPA, National Leader – Private Client Services & Loredana Scarlat, Director, Tax & Business Services

The Migration of High-Net-Worth Individuals to Low-Income Tax Jurisdictions Year-End Tax Guide

When it comes to taxation, our nation’s 50 states, cities, and localities have very different approaches and philosophies on tax collection. One state may not have any income taxes, but their real estate or sales taxes may be high. Some may apply the reverse, with high-income and lower real estate taxes, while others may be somewhere in between.

The decision to reside in a particular state has generally been driven by more personal factors: family ties, personal preferences, job and career prospects, to name a few, and less so by a state’s tax regime. However, different trends have emerged over the past decade. Factors such as the diversification of the economy, increased workforce mobility, or wealth-creating monetization events for various enterprises are now driving individuals’ residency considerations. For example, if a resident of New York, where the state tax rate tops at 10.9%, expects a large payout, they may be tempted to consider relocating to a lower tax jurisdiction.

The COVID-19 pandemic changed the world profoundly and shifted priorities. The scale of remote work has shifted the paradigm for many companies and individuals. If one could maintain their lifestyle, why not move to a state where the grass is greener, the sunshine brighter, and taxes – lower?

“However, residency break-ups are never easy, and high-income tax states dedicate a lot of human capital and financial resources to ensuring they get their share of tax.”

Currently, the top five highest income-tax states in the Union are California 13.3%, Hawaii 11%, New York 10.9%, New Jersey 10.75%, and Oregon 9.9%. New York State residents who are also New York City residents can add another 3.876% to their tax rate, bringing their rate to almost 15%. Now we have the answer to why New York City is the city that never sleeps.

The main difference between being a resident of a certain state and a nonresident is that the first gets taxed on their worldwide income, whereas the latter is taxed only on income obtained from sources within that state.

In determining residency, states apply two tests – domicile or statutory residency.

2023 Marcum Year-End Tax Guide

Domicile test

California and New York have similar approaches in this sense.

According to the California Franchise Tax Board’s Residency and Sourcing Technical Manual, a domicile is “the place with which a person has the most settled and permanent connection and the place to which the individual intends to return whenever absent. One’s acts must give clear proof of a concurrent intention to abandon the old domicile and establish a new one.” Establishing intent to remain in the new state permanently and indefinitely is an evaluation of facts and circumstances.

Despite common belief, changing one’s driver’s license, registering to vote in a different state, and signing a new lease do not weigh so heavily when considering the domicile matter. In New York audit cases, for instance, the following five critical factors are analyzed:

  • Home – if the taxpayer maintains homes in both states, the size, value, and use of homes are compared. Or more emotionally – to which home does the taxpayer return when traveling?
  • Active business involvement – where the taxpayer still maintains an active business in the old state.
  • Time – the percentage of time spent at each location. A mere day count would not weigh so heavily as a clear change in the patterns where the days are spent.
  • Near and dear items – where the taxpayer prefers to keep their jewelry or art collection or where their social clubs are.
  • Family connections – where the children attend school, where the spouse/partner lives, where the bank accounts are held, where the doctors are visited.

New York has two safe harbor tests against the domicile test:

  • The “30-day” test (no permanent place of abode in New York, maintain a permanent place of abode outside of New York, and spend no more than 30 days in New York during the year)
  • The “548-Day” test (for taxpayers who are abroad for 450 days of any 548-day period)

Statutory residency

Statutory residency is considered when someone maintains a ‘permanent place of abode’ (defined as a dwelling place fully suited for living, including access to furniture and utilities) in the old state.

California defines a “resident” as:

  • Every individual who is in this state for other than a temporary or transitory purpose; and
  • Every individual domiciled in this state who is outside the state for a temporary or transitory purpose.

There are two other alternative tests to determine California residency:

  • The outbound test: if a taxpayer is a domiciliary of California, he will be a California resident if his absences from California are temporary or transitory.
  • The inbound test: if a taxpayer is inside California for other than a temporary or transitory purpose, regardless of place of domicile, they are a resident of California.

For statutory residency purposes, New York has a two-prong test: day-count test – with the number being set at 183 days and maintenance of a permanent place of abode (PPA) for substantially all of the year. A PPA does not even have to belong to the taxpayer – it can be a corporate apartment, for instance.

Any part of the day on which the taxpayer sets foot, drives, swipes their credit card in New York, or makes a telephone call from New York (based on cell phone tower location) is considered a New York ‘day.’ The exceptions are flying in and out of a New York airport or in-patient medical treatment.

During a New York residency audit, the following are scrutinized: credit card receipts, EZ Pass records, phone records, social club bills, and utility statements. And New York is ready to subpoena this information from various third parties whenever the taxpayer gets overwhelmed with recordkeeping.

If, based on day count, someone is determined to be a statutory resident of a state, that person may end up with double residency, with one based on day count and the other based on their home state. This may be a double whammy as a resident credit may not be allowed or insufficient to cover the other states’ rate. For instance, a Connecticut resident deemed a statutory resident in New York is permitted a resident credit against New York paid taxes, but only up to the tax rate imposed by CT of 6.35% (compared to New York State top rate of 10.9%).

There is a silver lining to New York statutory residency – the presumption of residency may be rebutted when the taxpayer sells or leases out their New York home before the 11th month-mark in the year.

Even when residency audits are resolved favorably for the taxpayers, audits may be converted to allocation audits that seek to revisit the sourcing of various types of income to the state in question based on the number of days worked in the state.

Things are never as easy as packing up and going, especially for high earners. As mentioned earlier, recordkeeping is crucial. As many concepts are subject to a ‘facts and circumstances’ approach, securing the advice of a tax professional well-versed in the finer details of these types of state inquiries/examinations can make a difference worth tens of thousands of dollars.

2023 Marcum Year-End Tax Guide