If you split your time between two or more states, watch out for double taxation. Contrary to popular belief, there’s nothing in the U.S. Constitution or federal law that prevents more than one state from taxing the same income. And, although many states offer credits for taxes paid to other states, these credits aren’t always available.
The laws regarding multistate taxation are complex and they vary from state to state. Here is an overview of some of the concepts, but it’s critical to consult a tax advisor about your particular circumstances.
Domicile, residence and income source
Generally, if you’re domiciled in a state, that state has the power to tax your worldwide income. Your domicile is the place where you have your “true, fixed, permanent home.” It may also be defined as “the principal establishment to which you intend to return whenever absent.” Once you establish domicile in a state, it remains there until you establish domicile in another state.
The key to determining your domicile isn’t how much time you spend in a place, but rather your intent to remain there indefinitely or to return there. (See below “Where is your domicile?”)
States also have the power to tax the worldwide income of statutory residents. You can have only one domicile, but it’s possible to be a resident of two or more states. Typically, you’re a resident of a state if you maintain a “permanent place of abode” and you spend a minimum amount of time there during the year (such as “more than 183 days” or “more than six months”).
Also, states have the power to tax income derived from a source within the state, even if you’re not a domiciliary or resident. For example, if you commute across the border for a job in another state, your wages would be taxable by the state where you work.
There are several ways in which the same income can become taxable by more than one state. Suppose, for example, that you’re domiciled in state A but commute regularly to state B for business. Assume that the residency threshold in state B is 183 days. If you spend more than 183 days in state B and maintain a permanent place of abode there, state B may tax you as a resident, while state A taxes you as a domiciliary. And keep in mind that partial days are often included as full days. One possible way to avoid this result is to not own or rent an apartment or house (even a vacation home) in state B.
Many states offer credits for taxes paid to other states. For example, suppose state A allows residents domiciled in other states to claim a credit for taxes paid to those states, but only if those states offer a reciprocal credit to their residents domiciled in state A. In the above example, if state B doesn’t allow such a credit, your income would be taxable in both states.
Here’s another way you might be exposed to double taxation: Suppose you relocate from state A to state B and establish your domicile there. But, state A’s taxing authorities conclude that your domicile remains there while state B’s taxing authorities treat you as a domiciliary of state B. Both states apply their income taxes to your worldwide income. What’s more, although both states offer credits for taxes paid to other states, the credit is limited to taxes that are “properly due” in another state. In this case, each state views you as its domiciliary, so no taxes are properly due to the other state.
To avoid this outcome, study each state’s domicile standards and take all steps necessary to abandon your domicile in state A and establish a new one in state B.
A complex issue
These are just a few examples of the many complex issues involved in multistate taxation. If you believe you may be at risk, your tax advisor can analyze your exposure and identify steps you can take to avoid a double tax bill.
Where is your domicile?
Your domicile is the place you intend to stay indefinitely and return to when you’re away. Courts and taxing authorities look to a number of factors that demonstrate this intent, including:
- How much time do you spend in the state?
- Do you own or rent one or more residences in the state?
- Are you employed in the state?
- Do you conduct business in the state?
- Are your children, grandchildren or other family members in the state?
- Do you keep your prized personal possessions — such as artwork, furniture and heirlooms — in the state?
- Have you obtained a driver’s license and registered your car in the state?
- Have you registered to vote in the state and actually voted in the state?
- Do you have bank accounts and safe deposit boxes in the state?
- Do you use your local address for important documents, such as insurance policies, passports, tax returns, wills and trusts?
- Do you see physicians and dentists in the state?
- Do you attend a local church, synagogue or other religious institution?
- Do you subscribe to local newspapers and other publications?
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