Keys to saving taxes with a domicile change

While there is a range of factors driving migration in the U.S., undoubtedly taxes are a key driver for some, especially those nearing retirement.

According to recent data from the U.S. Postal Service, the two states experiencing the highest level of out-migration are California and New York. Both states rank in the top three in terms of highest marginal income tax rates (California is #1 and New York is #3). Conversely, the top two destinations (Texas and Florida) do not impose individual income taxes. Local taxes such as New York City income taxes or a new tax on real estate transfers exceeding $5 million in Los Angeles (the tax rate ranges from 4% to 5.5% and is borne by the seller) are considerations for many. Lastly, those residing in higher-tax states are further penalized when filing federal income taxes due to the $10,000 cap on deducting state and local taxes (SALT).

*Figure represents highest marginal tax rate.

Sources: U.S. Postal Service, Tax Foundation, income tax rates reflected are highest marginal rates.

Establishing a new residency for tax purposes can be tricky

For a person moving from one state to another looking for a more favorable tax structure, the process is straightforward if ties to their former state are completely severed. However, for those owning real estate in multiple states, it is more complicated. Simply spending more than half of the year in the more favorable tax state will generally not suffice. There is a difference between residency and domicile. You can have several residences but only one legal domicile.

“Domicile refers to someone’s true, principal, and permanent home. In other words, the place where a person has physically lived, regards as home, and intends to return even if currently residing elsewhere.”?(Legal Information Institute, Cornell Law School).

Because the nature of a domicile is based on “intent,” it is subject to interpretation. This can mean challenges for taxpayers facing an inquiry from a state tax authority. In general, the onus is on the taxpayer to prove a change in domicile, which is examined on a case-by-case basis depending on specific facts and circumstances. Be prepared to prove that your prior domicile was terminated and that the new domicile has been established.

In addition to tracking time spent in a physical location (for example, avoid spending 183 days or more in your previous home state), the more steps taken to sever ties with the previous legal domicile the better.

Here are some actions to take:

• Obtain a driver’s license in the new state
• Register car in the new state
• Establish a bank account in the new state
• File taxes using the new address, including quarterly estimated tax payments
• If applicable, file a declaration of domicile with the local county clerk
• Update legal documents, statements, insurance policies, etc., with the address reflecting the preferred domicile. Keep records of change of address requests
• Register to vote in the new location
• Change primary care physician
• Suspend business activities in the previous location, if possible
• Register children in school in the new location
• Join organizations in the new area (charitable or social groups, place of worship, etc.)
• If applicable, file a declaration of homestead in the new county or state
• Avoid leaving or storing valuable physical assets (jewelry, art) in the previous state

What is the 183-day rule?

Most states will rely on this metric when determining your permanent domicile. In general, if you spend 183 days or more residing in a state, that location may be considered your domicile. Their rule has some nuances, however. The time spent doesn’t have to be a full day to count toward the limit. Even part of the day spent in a location may count depending on the state. Also, for married couples, each spouse’s days may be counted separately. Lastly, some states do not require an individual to physically spend more than half of the time in that state in order to establish legal domicile in that state.

There are apps that can help simplify tracking your location for recordkeeping purposes such as?TaxBird?or?TrackingDays.

Remote work can raise tax questions

Since the pandemic, remote work has become a growing trend and more permanent part of the work landscape. As a result, many people are moving to explore new places to live while working for the same employer.

If you’re still working and spend a certain amount of time in a state, you may be required to file a non-resident tax return and pay taxes to that state. Income earned in another state might also be taxed in that state.

To challenge a domicile change, states will look at certain triggers to a potential audit such as a taxpayer who has historically filed a state tax return as a resident and then files as a non-resident if they have income sourced in that state subject to taxation. This may cause state tax authorities to take a closer look.

Document your journey to a new domicile

If your intent is to establish a new domicile, at some point you may be asked to provide documentation. Remember that someone making a successful domicile change will be able to prove they intended to leave their previous state permanently.

Be prepared, especially the higher your income level is, if you are contacted by your previous state tax authority to prove that you have successfully terminated your previous legal domicile.

State laws vary. It’s critical to work with a legal professional who knows specific state requirements before terminating or establishing a domicile.

More ideas for wealth management at Putnam.com

The opinions expressed here are my own and not those of Putnam Investments and are not intended as tax, legal, or investment advice.?Investors should carefully consider the investment objectives, risks, charges, and expenses of a fund before investing. For a prospectus, or a summary prospectus if available, containing this and other information for any Putnam fund or product, visit the?prospectus section, call your financial representative, or call Putnam at 1-800-225-1581. Please read the prospectus carefully before investing. Putnam Retail Management

333884