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Taxpayers who move in and out of the country should fully consider the state tax consequences of living and working in another jurisdiction. In this article, Mary Beth Lougen of American Expat Taxes explains the general considerations states use in determining whether a taxpayer is a domiciliary of that jurisdiction, and makes recommendations as to the steps practitioners can help their clients take to minimize risks of state tax liability. However, it can be a very costly exercise in taxation for your client without proper foresight and planning.
A taxpayer who fails to properly terminate state residency can incur thousands of dollars in income tax, penalties and interest years later. Even if a taxpayer thinks they have terminated their tax residency, the state may not agree. Currently seven U. Two others — New Hampshire and Tennessee — tax only the interest and dividend income of residents. The rest of the states and the District of Columbia have their own set of rules to determine who is a resident of their jurisdiction and thereby subject to taxation on world income.
There are two different types of residency for state income tax: domiciliary and physical residents. Although every state has its own set of particulars, there are generalities that we can use for this conversation.
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This means that taxpayers are responsible for filing state tax returns declaring their world income each year — even if they do not spend a single day in or have any income from that state. World income is all income received in the form of money, goods, property and services that is not exempt under the tax laws of the individual state, including income from sources outside the United States. In contrast, taxpayers who are deemed not domiciled or currently a resident in a state would report and pay tax only on certain state-sourced income.
The definition of state-sourced income for tax purposes varies by state, but practitioners can always count income from rentals, businesses, wages, and sales of real property interests to be subject to taxation for a state nonresident.
Dating in Virginia expats state-sourced income would not be taxed to a person who is not considered a resident — such as pension distributions, and interest, dividends and capital gains from personal portfolio investments. It is very important to discern whether your client, the taxpayer, will be considered a domiciliary resident or a nonresident after he accepts a position in another country so the taxpayer can file the correct form and include only the income he is legally required to on his state tax return.
Domicile is generally defined for tax purposes as the place where a person voluntarily establishes herself and family with the present intention of making it her true and permanent home. It is the place where, whenever absent, the individual intends to return. A person can only have one domicile at a time, and once established a domicile is retained until the taxpayer acquires another one.
Physical residence is based on a set of rules that when met, cause the person to become a resident for state tax purposes. It is not uncommon for a person to be a resident in one state and domiciled in another. Each state has its own rules that determine residency and nonresidency under physical presence. Residence under physical presence is not a concept relevant to this article, since residency defined by physical presence alone would not create an ongoing issue for taxpayers who move abroad.
Domicile and residence are two different concepts that are often used interchangeably. Residence is the jurisdiction where a taxpayer physically lives at that moment in time.
Domicile is the jurisdiction where the taxpayer intends to live, even if he or she does not currently live there. Current residence is not always the place where a taxpayer intends to live for the undetermined future. A taxpayer can be a resident of Canada, but be domiciled in California.
The repercussions of maintaining a state domicile while living out of the country vary widely with the particular state involved. The best scenario for the taxpayer is to be domiciled in a state with no income tax, or in Tennessee or New Hampshire where only investment income is taxable for individuals.
A worse case is for the taxpayer to be tied to a state that will tax their foreign income and provide no mechanism in the tax code to avoid double taxation of the income. Some states do not allow for exclusion of income under I.
Many U. This treatment avoids double taxation of the income by one of two different methods. As a general ordering rule when it comes to figuring out credits for taxes paid to another taxing jurisdiction, the jurisdiction of source has the right of first taxation, followed by the jurisdiction of residency. For example, Charlotte lives in southwestern New York near the Pennsylvania line.
She works in Pennsylvania. Charlotte would dating in Virginia expats a Pennsylvania nonresident tax return and declare her wages. New York has the right to tax her world income because Charlotte is a resident, but will allow her to reduce the New York taxes payable on her wages by the amount of tax she will pay Pennsylvania on the income.
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Thus, Charlotte is not double taxed on her wages. This is the same principal that is applied when calculating the foreign tax credit when a person is considered a resident for U. Some states allow a credit for taxes paid to other countries or foreign provinces. Other states allow a credit just to certain specific foreign countries. Secondly, avoidance of double taxation is accomplished by reciprocal state tax agreements where wages earned in neighboring states are only taxed in the state of residence. This is a much simpler approach to the same end — elimination of double taxation.
Wisconsin will neither require the withholding of Wisconsin state income tax, nor the filing of a Wisconsin tax return.
Effect of state domicile on expat moves: helping taxpayers determine when and how to keep or terminate state domicile
Charlotte will have Illinois withholding throughout the year and file a resident Illinois return reporting her world income. A similar principal exists inside the tax treaties the United States has with certain other countries. Tax treaties are reciprocal agreements between the governments of two countries that outline rules for the taxation of individuals and businesses resident in the other country. One of the goals of the tax treaties is the elimination of double taxation.
Some treaty-based positions mirror state tax reciprocity provisions, there is a common treaty provision that taxes social security benefits from either treaty country only in one of the countries. So if Charlotte moves to Winnipeg, Manitoba, when she retires, her social security will only be taxed by Canada. Unfortunately for taxpayers, not every state has included one of these provisions in their tax code where the income in question is from sources outside the United States.
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Alabama and California are two such states. If at any time before the day period is met, the taxpayers no longer meet the safe harbor requirements, they must amend any ly filed nonresident returns as residents and pay tax to California on world income for the entire period that falls outside the program. For example, Marge is a domiciliary resident of California and accepts an asment in London that is expected to last two years.
She packs up and moves on Dec. She can file her California tax return as a nonresident, taxed only on her Californiasource income, even though she has not yet been out of the state for the required days. Her mother falls quite ill during the beginning of and Marge leaves her London asment and returns to California to care for her.
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Now Marge must amend her tax return to a resident return and include her world income. California does not allow her to exclude her income using the Foreign Earned Income Exclusion, Formnor can she take a credit for taxes paid to the United Kingdom on her income. Her United Kingdom wages will be double taxed.
Even if a state provides a nonresident provision for domiciliary residents who are absent from the state, the above scenario of an asment terminating early, for whatever reason, should be considered and factored in to the compensation package. When a taxpayer begins to prepare for an overseas asment, he should speak with a professional who can help him decipher the state domicile rules and what they mean to the client given his personal situation. If the state does not provide relief from taxation while the taxpayer is out of the country, the taxpayer needs to decide whether to terminate domicile.
This means cutting ties to the state in a real and substantive way. A common mistake many people make is that they try to garner the best overall deal they can from their old and new residences by keeping what is beneficial as a resident from each place — perhaps discounted hunting or fishing s, a property tax exemption on a former personal residence, or keeping in-state tuition options open for who is almost out of high school.
These types of actions can give dating in Virginia expats state reason to reject claims of nonresidency and impose state taxation on world income. Taxpayers cannot have their cake and eat it, too, when it comes to state residency. Here is a list of things your client needs to consider doing to prove he or she has the intent to terminate domicile. When you are working with a client who is about to move to a foreign country for an undetermined amount of time, breaking domicile can be difficult to do.
But if the client commits to the process and breaks as many ties as they can, it can be done. With a solid plan, it is possible to break U. As a tax advisor, do your research! If you do not work in the world of expat taxation, speak to someone who is well versed in international tax. Confusion and misconceptions can occur when state guidance is written on a level most people will understand without being an expert, and you are dealing with an out-of-theordinary situation.
Always take it back to legal code, no matter what people write in articles or blogs. If you cannot identify it in the tax code or other official source, it can not be cited as a defense position in an audit.
Where the point is not clarified in code, look to other official sources such as decisions from a state tax court or tax commissioner, which can be used as precedence. Unless you have established residency in another state, you will still be considered a domiciliary resident of Virginia, and will be required to file Virginia income tax returns. Many people believe that this statement means that taxpayers cannot terminate Virginia domicile with a move to a foreign country.
At first read it would seem that way. The Virginia tax code provides the definition of domicile, but does not elaborate for foreign moves.
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However, a quick search on the Virginia Policy Library, Rulings of the Tax Commissioner yielded several foreign asments that resulted in termination of domicile. These types of rulings are essentially a textbook of how to terminate domicile for a particular state. One ruling outlines a husband and wife who were residents of Virginia, and in tax year the husband accepted employment in a foreign country. During August and Septemberthe taxpayers purchased and registered cars in Virginia, took out a new lease on a residence in December, and moved back to Virginia to live.