State tax residency issues.

• Author: McGowan, Jeffrey M.

Taxpayers should attempt to arrange their business and other economic activities to effectively minimize the income they apportion and allocate to states with high marginal tax rates. These efforts should entail determining the effect an individual's business activities has on compliance with the various tax laws in the states where the business activities occur. A key component in implementing such a strategy is identifying a taxpayer's residence and tax domicile.

For instance, as was recently noted, "an administrative difficulty that arises [in payments on behalf of nonresident owners] is tracking the residency status of partners/members/shareholders. The owner's mailing address may not provide a reliable basis from which to determine the state of residence"; see Schneyman, Tax Clinic, "Tax Payments by Passthrough Entities for Nonresident Owners," TTA, October 2003, p. 602.This column explores the issues surrounding residency/nonresidency of an individual's business and passthrough entity holdings, as well as the ability of states to tax compensation and deferred income.

Residency determinations are critical to individual income tax planning. A tax saving idea, such as shifting income from a high-rate state to a low-or no-rate state, must be weighed against a state's ability to impose income taxes on all income of an individual considered to be a resident in the state. Conversely, a nonresident (generally defined as anyone who is not a resident) is taxed only on income earned within the taxing state.

Residence in one state may not preclude another state from taxing the same income, if the "nondomiciliary" state finds that some (or all) of the income was earned from property located in, or activities taking place, within its borders. This emphasizes why residency is critical for planning and reporting business activities.

Determining Residency

Most states use some common criteria to determine residency; see the exhibit on p. 771. But, in general, they usually employ four factors, either alone or in combination, as a test: (1) in-state domicile; (2) presence for other than a temporary or transitory purpose; (3) presence for a specified period; and (4) maintenance of a permanent in-state abode.

An income tax "domicile" is usually the same as a "permanent home"A domicile, according to NYCRR [section] 102.2(d) (1), for example, is "the place which an individual intends to be his permanent home--the place to which he intends to return whenever he may be absent." If the domicile changes, the individual bears the burden of proving that a new one has been established; see Lawrence v. Mississippi State Tax Comm'n, 286 US 276 (1932).

Many states use a physical presence test (normally based on days) to determine whether an individual is a resident in the state. Although New York law defines a resident as a person domiciled in the state, it contains exceptions for taxpayers who are out of the country for extended periods or who have two residences and spend less than 30 days of the tax year in New York; see NY Tax Law [section] 605(b). A resident also includes any person not domiciled in the state who maintains a permanent abode there and spends more than 183 days of the tax year in New York, unless he or she is in active service in the U.S. armed forces. Thus, New York executives and employees domiciled elsewhere, but maintaining a New York presence for the requisite period, are taxable residents.

As exemplified by New York's residency criteria, taxpayers need records to support a domicile or residency change. State residency determinations can be extremely fact-intensive; usually the taxpayer bears the burden of proof. Thus, proper documentation can avoid unnecessary tax liabilities. Records showing the time and...