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Residency Rules and Traps for the Unwary

10/01/2014

Many people live, work (or both) in more than one state. The degree to which a person works or lives in another state (other than their home state or state of domicile) can present complex individual income tax challenges, necessitating either accurate record keeping or without accurate record keeping, increased risk and exposure. In general, there are two concepts to consider when determining an individual’s filing status in a particular state. Those concepts are “domicile” and “residency.”

The concept of domicile is important in that, in general, an individual will file income tax returns and pay tax to the state of domicile. Typically, an individual will pay tax to the state of domicile, because the individual would live and work in that state. However, individuals who have split residency or work assignments outside the state of domicile may have challenging issues. An individual may have to file a tax return as a “resident” of a state, even if the individual considers their “true” home or domicile to be elsewhere, if they meet certain conditions.

Although Tennessee does not have a tax on wages, the state does have a definition of “legal domicile” for determining whether or not an individual is subject to the income tax on interest and dividends (the “Hall” income tax). The definition listed in the return instructions states that “Some items considered in determining 'legal domicile' are: where you are registered to vote, where you maintain your driver's license, where you maintain your permanent or principal residence (as opposed to a special-purpose or temporary residence, such as a vacation home, etc.).” Additionally, persons whose legal domicile is in the state, persons who have moved into or out of the state during the year, or persons who are domiciled in another state but maintained a residence in Tennessee for more than six months during the year may have to file the tax if their interest and dividend income exceeds certain thresholds.

Each state has its own definitions of the terms "domicile" and "resident." For example, New York's definition of “domicile” and resident" is much more expansive than Kentucky's definition of "domicile" and "resident."

Accurate record keeping would be required to determine if an individual should file in one of those states as a “resident” or in the alternative, a non-resident or a part-year resident. Many individuals have had to supply proof of location throughout the year upon audit (particularly by New York since New York aggressively conducts residency audits). This could involve keeping accurate calendars, credit card receipts for purchase, or other proof of location, day by day.

Why does this matter? Generally, all income is subject to tax in the state where an individual is a resident, regardless of where it was earned. However, an individual who does not meet the 183 day rule may be required to file as a non-resident of a state that imposes an income tax (Kentucky for example), but only required to report income from sources within that state. Individuals who move in or out of a state during the year might be required to file as a “part-year resident” that would involve both elements of a “resident” and a “non-resident” filing.

Some states (such as Kentucky) have reciprocity agreements with other states. These reciprocal agreements mean that taxpayers are taxed in the state of residence, and not the state where the money is earned. However, reciprocity does not apply to persons who live in Kentucky more than 183 days during the year.

These rules could be particularly important for those that are domiciled in state such as Tennessee that does not have an individual income tax (on wages), but that work full time or on work assignments in another state. Additionally, some professions (such as professional athletes) may be aggressively pursued for their portion of state income taxes, irrespective of the number of days that they spend in a state (even a single day).

Questions? For more information, please contact one of our team members.