Residency Pitfalls

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November 11, 2009

There was an interesting local income tax case recently, involving billionaire Julian Robertson. Mr. Robertson had a New York City residence in 2000 (among others), but wanted to avoid being taxed as a NYC resident, owing to that city's high tax rate (in addition to federal and state taxes). Thus, he carefully managed his presence in NYC to meet the statutory requirements necessary to be considered a non-resident. His savings: $27 million.

For most of us, the implications of where we live and work are far less significant, but they're still meaningful. Compare a state like Texas, with no individual income tax, with New York City, which levies both state and local income taxes at high rates.

Taxpayers are assessed state income taxes (ignoring local taxes and lucky states with no income tax) based on where they live and/or work. For a taxpayer that lives and works in the same state (most taxpayers), the employer withholds state taxes from the taxpayer's pay and annually the taxpayer files an annual state return, receiving a refund of taxes paid or paying additional tax.

For taxpayers with multiple residences, this gets more complicated. Each state has rules for when that state is a taxpayer's "tax home", which usually hinge on the amount of time a taxpayer spends in the state. A taxpayer can claim residency in any state in which he or she maintains a residence. Or, like Mr. Robertson, a taxpayer can arrange his or her affairs to ensure residence in a particular state. Residence, like many other items, may be reviewed as part of an audit or other examination of a taxpayer's return.

Some taxpayers live and work in different states. A taxpayer who lives, for example, in New York and works in New Jersey will likely file in New York as a non-resident, New Jersey as a resident, and take a credit on his or her New Jersey tax return for taxes paid to New York. The net effect is that the taxpayer likely ends up paying the higher tax rate.

Certain states have so-called reciprocity agreements. These are usually between neighboring states with many workers that live in one state and work in the other. They basically enable the taxpayer to only file in his or her home state. However, these agreements may be losing favor: Minnesota recently ended its reciprocity agreement with Wisconsin (beginning in 2010), because it wasn't getting paid its owed tax revenues by Wisconsin quickly enough.

For students that go to school out-of-state, work in that state and are claimed by their parents as a dependent, the same analysis typically applies. Even though the student is living out-of-state, living at school is usually considered a "temporary absence" and the student remains a resident of the state in which his or her parents live. Thus, the student would have to file as a non-resident for wages earned in the state where he or she goes to school and a resident in the state where his or her parents live, and take a tax credit on the resident return for taxes paid to the non-resident state. As if students don't have enough to think about!

The issue of residency can be a complicated one, particularly if a taxpayer lives and works in multiple states. If you have a complex situation, we encourage you to contact us and we'll help you sort out the issues.