My guest at this time is Kathleen Theis, practice leader for our state and local tax group here at CLA. Kathleen, thanks for joining me.
Thanks for having me.
When we had our CLA Outlook tax perspectives, we were talking through state residency planning. And I thought, what a better follow up than to have you join us and talk through what this service offering is and where we see a need with our clients. Can you explain what this is at a high level for us?
Sure. Thanks, Carey. State residency planning is when we work with our clients to look at the state tax consequences of where they're living, where they work, where they have businesses, and where they spend time. What we're noticing in a kind of a post-COVID world is people are able to move around, live where they want, work where they want, and those have tax consequences.
We want to be thinking through what are those consequences for our clients, and can we do things to help mitigate taxes, have them understand the landscape of the differences from state to state?
I understand in the post-COVID world, but what is making this such a hot topic with our clients right now?
States are really in revenue shortfall positions. So they're really aggressively trying to figure out ways that they can tap into revenue.
Certainly high-net-worth clients are the ones who are being hit the most. We're seeing millionaire taxes be enacted across several states. Massachusetts, for instance, has had a lot of success collecting a lot of revenue.
And I think other states are catching on to that. So now we're seeing legislation in Washington, California, and New York. We should be thinking about those high tax jurisdictions and making sure we're talking to our clients about some of these planning opportunities.
A common fallacy we hear is, “Why can't I just move to a non-income tax state jurisdiction like a Florida or a Texas to avoid this problem?” Can you share a little bit about why it's not that easy.
There's a couple reasons. One — we think about income tax, and I think we can get siloed into “If I get out of a state that has an income tax into a non-income tax state, I'm going to not pay any tax.” That's obviously not true. You need to be thinking about property tax, sales use tax, other business and licensed occupation taxes.
As well as many of our clients are business owners, and they might have multi-state operations. Moving to Texas and being the owner of a business that's active in multiple states will not get you completely out of tax, but it can help. We could help model out those different scenarios for clients.
My last question for you, I'll get you out on this, is what are the most successful things that you can do with a client when it comes to residency planning?
As being trusted advisors for our clients, we should be understanding what their goals are, where they're at in their lifecycle of their business, where they're at in their lifecycle in terms of retirement or liquidity events. It's very important to understand what their goals are and to let them know there are ways to mitigate state tax.
We don't want state taxes to drive necessarily where someone's going to live, but we do have the ability to work with our clients and not be reactive to some of these events. Especially in the context of if you want to sell a business, it's great if we can have those discussions two-to-five years ahead of any sort of event. We make sure we are arming our clients with the right information, and they can make those decisions.
Key insights
- Moving to a state with no income tax may not lower your overall tax burden once property, sales, estate, local, and business-related taxes are considered.
- State residency rules can be complex, and individuals may risk being taxed as residents in more than one state if domicile and statutory residency rules overlap.
- Business owners considering a move should model the full multistate tax impact before a sale, transition, retirement, or major life change.
Assess your full tax picture before moving for potential savings.
Paying no state income tax may sound appealing, but it’s rarely that simple, especially if you’re a business owner.
Changing your state residency involves more than changing your address or buying a home in another state. You also need to consider where you live, work, own property, operate a business, and keep the records needed to support your position.
Many people are revisiting state residency because of remote work, retirement, business transitions, and changing state tax rules. High-income individuals, business owners, and executives may have more to consider before making a move.
Should you move to one of the nine states without state income taxes, including Florida, Texas, and Nevada? If you have ties to more than one state, what tax issues should you review before making a move? The answer depends on your income, business interests, property, investments, and personal facts.
How does state residency affect your taxes?
Nonresidents are generally subject to state personal income tax only on income connected to that state. Residents, however, are typically taxed on all income wherever derived, including wages, passthrough income (K-1s), and passive and portfolio investment income.
Because resident-state taxation can be broad, and rules vary by state, it’s important to understand both the potential implications and benefits when evaluating residency.
What determines your state of residence?
State residency determinations generally fall into two classifications:
Domiciliary resident
Domicile is a subjective standard that considers your intent to make a state your primary home. States generally look at six factors when determining whether someone is a domiciliary resident:
- Time spent in the state
- Type and use of home
- Employment or business relationships
- Location of near and dear items (such as family heirlooms and photos)
- Family connections
- Miscellaneous factors (such as mailing address, driver’s license, voter registration, location of doctors, and memberships, etc.)
Statutory resident
Some states have statutory residency rules, where you can be considered a state resident even if it is not your domiciliary state. States imposing this classification consider whether you have a home in the state (owned or leased) and whether you spend more than 183 days in the state. If so, you may be considered a state resident.
Moving may not resolve every state tax issue
Moving to a state without an individual income tax can help reduce state income taxes, but it may not eliminate tax exposure in other states. You may still have filing obligations or tax liability if you own a business, receive pass-through income, own real estate, receive equity compensation, or earn income connected to another state.
Before changing residency, review where your income is earned, where your business operates, where your property is located, and which states may still tax part of your income.
Who should consider state residency planning?
State residency planning may be especially important if you:
- Live in a high-tax state and spend time in another state
- Own a business or expect to sell or transition a business
- Receive significant equity compensation
- Own homes in more than one state
- Spend time in multiple states for work, family, or lifestyle reasons
Should you change your state residency for tax purposes?
A lower individual income tax rate is only one part of the equation. Property taxes, sales and use taxes, estate taxes, local taxes, business-level taxes, and income sourcing rules can also affect your overall tax bill.
Other taxes to consider include:
- Property taxes — Property tax rates vary greatly depending on state and region.
- Sales and use taxes — A no-income-tax state may have higher sales tax or broader taxability on purchases and services.
- Estate and inheritance taxes — Some states impose their own estate or inheritance taxes, which can matter for wealth transfer planning.
- Business license, gross receipts, and occupation taxes — Business owners may still face entity-level or local taxes even if they move to a different state.
- Franchise or entity-level taxes — LLCs, partnerships, S corporations, and C corporations may owe taxes based on revenue, net worth, capital, or doing business in a state.
- Payroll and employment taxes — These costs are relevant if your business has employees, remote workers, or owners performing services in multiple states.
- Unemployment insurance and workers’ compensation costs — These vary by state and can affect operating costs.
- Real estate transfer, excise, or documentary taxes — A factor when buying or selling homes or business property.
- Local taxes — Cities, counties, and municipalities may impose income, business, property, sales, or occupancy taxes.
- Pass-through entity taxes and credits — Business owners should model how state-level PTET regimes could affect overall tax liability.
- Industry-specific taxes — Depending on the business, there may be taxes on fuel, hospitality, insurance, health care, construction, cannabis, alcohol, or other regulated sectors.
State residency and tax considerations for business owners in transition
Selling or transitioning your business can be one of your most significant financial and tax decisions. Whether you sell or gift the business to a family member or sell to a third party, state income and other state-specific taxes should be considered before the transaction occurs.
If you plan to transition your business in the next several years and are considering a move, work with an experienced business transition advisor to model the state tax consequences before the transition occurs. Once a sale or transition is complete, some planning options may be more limited.
What tax considerations should you weigh for state residency?
Total tax picture beyond state income taxes
State income taxes are only one part of the analysis, especially if you own a business, have investment income, receive equity compensation, or have ties to more than one state. Before changing residency, evaluate your full tax picture.
Dual residency for state income taxes
If you have ties to more than one state, more than one state may treat you as a resident. For example, one state may view you as a domiciliary resident, while another may treat you as a statutory resident based on your home and day count.
Proactive planning can help reduce unexpected tax exposure when you have ties to more than one state. Since domicile determinations depend on facts and intent, review prior and future residency patterns before taking a filing position.
Because there is no single list of items that establishes residency for tax purposes, a taxpayer's facts and each state's rules should be reviewed together. Proper planning and documentation can help support a position if a state asks questions.
Documentation matters for state residency audits
State residency audits are fact-specific. States may review day counts, home usage, business activity, family connections, voting records, driver's licenses, mailing addresses, and the location of personal items. No single fact usually determines the answer.
Keeping clear records as decisions are made can help support your residency position if it is questioned later.
How CLA can help with state residency and state income tax considerations
Changing your state residency can affect more than your individual income tax rate. CLA can help you evaluate the tax impact of a potential move, model multistate scenarios, and understand how residency rules may apply to your facts before you make a decision.
Our state and local tax professionals can work with you to review filing positions, identify potential exposure, and develop documentation to help support your residency position if questioned by a taxing authority. These conversations may also connect with wealth advisory, estate planning, transaction planning, and business transition planning.