What Determines Your State Residency for Tax Purposes?

September, 05 2024 by Glynis Miller, CPA, MST

To the average person, this may seem like a silly question. For them, the answer may be easy, as it is the state they were born in and have always lived in. But the answer to this question is not always so cut and dry to answer for thousands of other taxpayers. Let us look at why it is not so simple and the importance of why taxpayers must understand what makes it complicated. Knowing the possible issues and how to report income is the best way to avoid receiving an unexpected tax bill from a state taxing agency.
 

Things that make it complicated

For many people, the normal workday routine is to get up in the morning and leave home to drive to work within the same city and state they live in. Others, such as those living close to a neighboring state, may drive to work in the next city, but it is just across the state’s borderline. In addition to those just mentioned, some people travel from state to state in the normal course of completing their job functions, and spend days, weeks, or months within a single tax year in multiple states.

For example, professional athletes play games in multiple states throughout the season. While the players are traveling from state to state during the season, some are residents of a state that is different from the state where the team they play for is located. Another consideration is telecommuting. Telecommuting has been around for years, but most people were employed and lived in the state where their employer was located. However, the recent pandemic forced many people to work remotely. In areas like New York, New Jersey, and Pennsylvania, it is very common for taxpayers to live in one of those states but work in one of the other states. As a result of the pandemic, in states such as New York and New Jersey, many taxpayers were not physically driving to the office in another state. Instead, they were allowed to work remotely from home. These actions have caused a lot of issues over the last few years, prompting many states to adopt certain rules that may change where the earnings are considered to be earned.

To add more complications, military personnel and their spouses get special rules. Military personnel and their spouses may be able to choose their state of residency for tax purposes. For example, a service member may be stationed in California, but his residency for tax purposes is in Texas. The rules related to military personnel and spouses can be even more complex, but they will not be addressed in detail in this blog. It is important to remember, when trying to determine state residency issues, to look at all filing requirements based on the facts and circumstances of both spouses, especially when it comes to those serving in the armed forces.
 

Domicile

Whether a taxpayer must file a tax return in any given state is generally based on the source of the income, but their tax home is usually dependent on where they are domiciled. Taxpayers who spend time in more than one state must look at each state’s rules to determine residency. Since the key deciding factors for residency are related to a taxpayer's domicile, it is important to know what is generally meant by domicile. If you look up the definition of domicile in the dictionary, it indicates that one’s domicile is the country that an individual either lives in, has a substantial connection with, or treats as their permanent home. So, federally, it is pretty simple to note that as a U.S. citizen, one would generally be considered domiciled in the U.S., even if they do not physically live there. However, the U.S. is made up of multiple states, and each state has its own rules regarding the taxation of its residents and non-residents who earn income from within its state. Those complex rules generally refer to a person’s domicile when determining the state of residence for tax purposes.

It should be noted that domicile is not usually clearly defined in the state's tax code, but most states will have specific information available regarding how they determine domicile or residency in the instructions for filing or as separate information on their website. When considering one’s domicile, it should be noted that someone may own multiple homes in multiple states, which can make determining a domicile more difficult. They can even split their time during a tax year between two different family residences. However, they will only have one domicile, though it can change at any time.

Here are some of the key factors related to domicile:

1. Primary Residence - Where you physically live is usually an easy question to answer. For those who own more than one residence, it could be a little more difficult. Many people will state that they split their time equally between one state and another. However, only one residence will generally be considered the primary.
2. State for Voter Registration (or state for which one could be registered to vote) - Where you have registered to vote often indicates where you have dedicated your community interests and strongest ties.
3. Car and Vehicle Registrations - Where you have your cars registered can indicate a sense of permanence.
4. Driver’s License – Generally, a state will allow out-of-state drivers to drive without getting a state-issued license if the individual is only temporarily there. Thus, which state issued your driver's license will go a long way in determining domicile.
5. Legal Address – The address you use on legal documents, tax returns, business filings, and bank and brokerage statements. Since these documents are very important, the address used on them generally indicates that the home they are sent to is to be considered the main home or potentially where you spend the most time.
6. Employer – Office Assignment Location - Companies can operate in multiple cities and countries and may have various physical locations. Which location you are assigned to can play a big role in the determination of your state of residency.

For example, suppose Jane, a taxpayer living in Los Angeles, California, is assigned to a local office in Los Angeles with her employer. Jane goes into the office a few times a year for meetings but does not have to travel for work outside the state of California. Since Jane lives in the state and her assigned office is also in the state, it is not hard to determine that California is her state of residency for tax purposes.

Now, let us change a few details about Jane to see what happens. If everything were the same except Jane now lives in Colorado. Although Jane lives in Colorado, her office assignment is still in California, and her employer does not have any physical buildings in Colorado. Jane is still required to come into the office a few times a year for meetings but does no other business-related travel. For tax purposes, it is clear Jane is a resident of Colorado, but she has California wages. Jane will need to file a non-resident California tax return, but she will also need to file a resident tax return in Colorado.


 

Dual Resident

In certain cases, it is possible for someone to be considered a legal resident of more than one state. They will still be domiciled in just one but, based on other factors, the non-domicile state will likely consider them a statutory resident, resulting in a dual residency status.

Items that may make you a dual resident:

• Days Physically Present – Most states use 183 days or more as the benchmark for residency in the state, so if you spend that much time in the state, you are a resident.
• Place of Abode – The states will consider if you own or rent an abode, a residence that is available to you all year long. It is fine to own the property but having the property and being physically present for 183 days during the year complicates matters.
• Family ties or connections – If one has family in a non-domiciled state, it will be considered. For example, although it may be rare, there are cases where spouses live in different states but own property jointly in each state.

Double Taxed

For years, people have been under the impression that a tax return is only required in their state of residency; as discussed above, that is not the case. However, by having to file both a nonresident and a resident tax return, some or all of a taxpayer’s income could be subject to double taxation. In most cases, the effects of double taxation can be reduced by taking the credit for taxes paid to another jurisdiction. It is important to understand which state you are a resident of and which one you are not, then review the rules to see if you can take the credit for taxes paid to another jurisdiction and on which return it should be reported when available.

If Jane, from our example above, lived in Texas, where there is no state income tax, her income would not be double-taxed. She would have to pay taxes to California but not Texas. Again, this makes it clear that many people may have assumed that if they live in a state with no income taxes, they do not have to pay state taxes on any of their earnings. This is not true, and understanding the importance of determining the state of residence for tax purposes can go a long way to filing accurate tax returns. So, before you file your next tax return, or that of someone else, be sure to consider all facts and circumstances that determine residency for tax purposes before just filing a tax return.