Understanding Residency and Domicile in Determining State Income Taxation
State income taxes play a prominent role in overall tax planning for individuals. A change of residence/domicile from a higher-tax state to a lower- (or no-) tax state is often considered when contemplating retirement or the receipt of significant proceeds from a business or investment transaction, or when a taxpayer realizes the amount of state income tax paid upon filing his or her return. Nine states currently have no income tax—Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming—and the rate of state income taxation varies considerably among the states.[*] A change of residence/domicile can be a practical way to decrease state personal income tax liability and preserve wealth.
Residency/domicile is a critical issue in determining state taxation. The general rule is that a state may tax the worldwide income of a person domiciled in that state. Nonresidents of a state generally only pay income tax with respect to income actually sourced from that particular state. In addition, an individual who meets the statutory test of residency in a state, typically based on presence in the state for a designated number of days, commonly 183 days, may be classified as a statutory resident and subject to tax on all of his or her income, regardless of its source. A “day” in this context typically means any part of a calendar day, except when presence in the state is solely to board a plane, ship, train, or bus for a destination outside of the state. States may provide for other exceptions to this “day” rule, including presence in the state for medical care, presence for purposes of military service, and the like.
While every state has its own approach to taxation, it is important to first recognize the difference between domicile and residency. States vary in their definitions of these terms, but generally agree that domicile is a subjective analysis based on a person’s permanent residence (i.e., the place where an individual has his or her true, fixed, and permanent home without any present intention of leaving, and to which the individual intends to return when absent). An individual can only have one domicile at any given time. Residency can be the same as a person’s domicile, but it also can be a person’s temporary residence (i.e., a second home). A person can have more than one residency in a single tax year.
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