Taxation and Residence

Taxation and Residence

States are facing the issue of how to manage spending given declining tax revenue due to the pandemic, so they are taking another look at the taxation of residents and non-residents.

How does a state tax a nonresident on income?

For the majority of states, nonresident income tax applies only to those wages that are earned for work performed within the nonresidential state. Under the usual conception, if an employee is a resident of New Jersey and works one month in New York, only wages earned for that one month in New York are subject to New York nonresident income tax. However, New York is one of seven states that has adopted what is known as the “convenience rule” to govern what determines whether the wages are earned in their state.

The rule suggests that your income is taxed based on where your office is located, rather than your residence, even if you aren’t using the office or geographically in the state on those days. New Jersey also has a reciprocity agreement to prevent double taxation, so the taxpayer would receive a credit against any further income taxes based on what they have already paid.

What is the reasoning of the convenience rule?

This would allow for commuters that use the New York offices to have their income taxes support that infrastructure around them such as public transport. Though it may have applied to those that only rarely visited offices or headquarters, that was unlikely to be the majority of cases.

Last month, New Jersey joined a group of states in filing an amicus brief in opposition because of how work dynamics have changed over the last year. The new remote work dynamic has increased the number of those cases regarding offices that are were not used at all, and employees who have spent zero days in the last nine months in New York are still being categorized as earning their income in the state of New York for those days. The brief suggests that this is not appropriate and that New York shouldn’t have the right to tax income of residents from other states that isn’t earned in New York.

According to a recent article from the WSJ, the tax amounts being discussed are substantial:

“The fiscal implications of changing the taxation rules run in the billions of dollars, according to budget officials from several states. In 2018, around 434,000 New Jersey residents paid $3.7 billion in New York income taxes, according to the New York State Department of Taxation and Finance.”

This debate isn’t new, but the dynamics are different so it is reasonable to review it again. This may have further implications as well. Earlier this year, California had proposed a wealth tax that would continue to tax non-residents on their wealth for 10 years after they had exited the state. The tax did not proceed, so its legitimacy was not tested; but the question of the degree of taxation allowed for non-residents is likely to become larger.

How is residence determined for tax purposes?

Traditionally, it’s demonstrated by accounting for time spent in various states throughout the year. When large amounts of taxes are at stake, additional sophisticated measures may be taken by the state to determine the authenticity of residency.

For high-net-worth individuals, taxation generally isn’t the first priority in terms of deciding where they want to live. Nevertheless, it is a headache that needs to be dealt with by them or their estate.

One test – where is your teddy bear?

In New York days spent is only one measurement. The state also looks at the size and cost of the New York home compared with those in other states, a person’s business and family ties to the state, and a category that looks at where ‘near and dear’ items are kept. Items such as their “teddy bear.” In addition to checking for stuffed animals or pets, states may examine cell phone records and Facebook posts.

Steps to establish a new residency:

When residency is hard to prove, legal battles may ensue that are more painful than tax savings that might have been achieved by being in a lower taxed state. Taking steps such as these to establish residency may avoid some of that frustration:

  • recording the number of days spent in the new state
  • registering to vote in the new state
  • obtaining a new driver’s license
  • registering one’s car in the new state
  • updating estate plans, noting the new residence
  • joining a new church or temple

At Garden State Trust Company, our professionals deal with both simple and complicated estates, with multiple homes or businesses that exist in multiple states. We’re familiar with these issues. Please don’t hesitate to contact us for a consultation to ensure a clear transition for your family.