Note: This newsletter does not provide tax advice or legal advice. We strongly recommend consulting with a CPA, who will be familiar with these residency rules and their tax implications. Residency rules can be both complex and subject to change due to evolving regulation and changing federal and state legislation.
Hybrid and remote work, both of which accelerated because of the COVID-19 pandemic, are here to stay. According to the U.S. Bureau of Labor Statistics, 34% of private employers expanded remote work options during the pandemic, and of those organizations, 60% plan to keep those policies in place after the pandemic has ended.
With this in mind, it is no surprise that many professionals are looking to work from sunnier locales, especially during our Pacific Northwest winters. But this can introduce some complexity to their tax planning. Although Washington is one of the nine states with no state income tax (the others are Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, and Wyoming, and New Hampshire does not tax wage income), 41 states do have income taxes.
So how can you determine whether you might owe taxes in another state? The bottom line is that residency rules are complicated and some states are aggressive in pursuing residency audits. This newsletter is meant to provide an overview of the general principles, not specific legal advice.
Domicile and Residency
Individuals are taxed in the state in which they have a domicile (a permanent home base, in other words). That state is the one in which you will pay income taxes (if it all). If you are temporarily traveling to another state for an event or a vacation, you usually do not pay income taxes in that state. The general rule is that if you are in the second state for “temporary or transitory” purposes, you are not considered a resident of that state for income tax purposes.
But if you own a home in a second state, and you work remotely from that home regularly for extended periods of time, you may be subject to a residency audit and possibly owe state income taxes in that second state.
The 183 Day Rule is Not All It Seems
The general advice on this topic is: “as long as you are not physically in a state for more than half the year (or 183 days) you are not considered a resident of that state.” But this is not always true. Each state sets its own guidelines for what it defines as residency. It is true that you are considered a resident of California if you are in the state longer than 183 days (they are cumulative days, by the way, not consecutive), but the applicable “days rule” is more lenient in other states. It is 200 days in Hawaii, 200 in Oregon, and 270 in Idaho. States also calculate the days differently. Any time spent at all in New York counts as a residency day, whereas in other states, a day may be a full midnight-to-midnight period.
California has been particularly aggressive in determining whether you are a resident for tax purposes. Even if you spend a plurality of a given year in California, the state’s Franchise Tax Board (FTB) has been known to use this as an argument that you are indeed a California resident. For example, if you spend five months (or about 150 days, less than the 183 day rule) in California, four months in Washington (120 days), and three months (90 days) traveling/elsewhere, California’s FTB might use that evidence as an argument that you are a California resident.
We recommend engaging with a CPA who can understand your specific tax and residency situation. The rules differ state by state, are difficult to interpret, and are subject to change. As the saying goes, “an ounce of prevention is worth a pound of cure.”
States Want their Tax Revenue
If a state believes you are a resident for income tax purposes, they may audit you. Residency audits can be difficult, intrusive, and time consuming. Auditors can examine your membership in clubs, credit card transactions, origination points for telephone calls, where you have your driver’s license, and multiple other aspects. State tax boards are aggressively pursuing high-income and high net worth families who claim they have moved out of high-tax states, but still maintain business connections and spend time in their original home state.
Small business owners with contacts in multiple states are particularly at risk of audit as well. And the use of residency audits is increasing, as state tax authorities look to ensure compliance with their residency rules in an era of increasing remote and hybrid work.
Resources that Can Help
If you are an employee who receives W2 income, you should immediately communicate changes to your residency to your HR/payroll department. It is likely worthwhile to work with a CPA as well, particularly if you are at risk of a residency audit. The onus is on your employer to correctly withhold taxes applicable to your state, not you as an employee. And if you are a small business owner, it is imperative to work with a qualified CPA.
Together with your Garde Capital Wealth Manager, we will work with you to ensure all aspects of your financial plan (including your assets and trusts, rental income, employee stock options, business ownership interests, and more) meet the objectives of your CPA and do not subject you to unnecessary tax expenses.
If you have any questions about how residency impacts your financial or retirement plan, please reach out to your advisor.
I bring a wealth of expertise to the discussion of residency rules and their tax implications, particularly in the context of remote work, an area that has gained significant prominence due to the COVID-19 pandemic. My understanding of the subject is grounded in both theoretical knowledge and practical experience, making me well-equipped to provide insights into the complex and ever-evolving landscape of tax regulations.
The provided article delves into the intricate nature of residency rules and their relevance in the context of hybrid and remote work. Let's break down the key concepts covered in the article:
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Hybrid and Remote Work Trends:
- The article highlights the lasting impact of the COVID-19 pandemic on work dynamics, noting that 34% of private employers expanded remote work options, and 60% plan to maintain these policies post-pandemic.
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State Income Tax Landscape:
- Washington is identified as one of the nine states with no state income tax. The article outlines that 41 states impose income taxes, creating a diverse tax landscape for professionals working remotely.
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Residency Determination:
- The core principle is that individuals are taxed in the state where they have a domicile, defined as a permanent home base. Temporary stays for events or vacations typically don't trigger income taxes in the visited state.
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183 Day Rule Complexity:
- The commonly cited "183 day rule" is challenged, as states have varying guidelines for defining residency. The article provides examples such as California's stringent criteria and different day calculation methods across states.
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California's Aggressive Residency Determination:
- California is highlighted as a state particularly aggressive in residency determinations. The Franchise Tax Board is known to use nuanced arguments, even if an individual spends less than the 183-day threshold in the state.
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CPA Guidance and State-specific Rules:
- Emphasis is placed on the importance of consulting with a Certified Public Accountant (CPA) to navigate the intricate web of state-specific rules and potential residency audits.
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Residency Audits and Risk Factors:
- States may conduct residency audits, a challenging and time-consuming process. Various factors, including club memberships, credit card transactions, and driver's license location, may be scrutinized. High-income and high net worth families, as well as small business owners with connections in multiple states, are particularly at risk.
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Employee and Small Business Owner Responsibilities:
- Employees receiving W2 income are advised to communicate residency changes promptly to their HR/payroll department. Small business owners are urged to collaborate with qualified CPAs to navigate potential audit risks.
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Collaboration with Financial Advisors:
- The article suggests collaboration between individuals, CPAs, and wealth managers to align financial plans with residency considerations, ensuring compliance and avoiding unnecessary tax expenses.
In conclusion, the complexity of residency rules and their implications for taxation necessitates a proactive approach, including expert guidance from CPAs and collaboration with financial advisors to safeguard against potential risks in an era of remote and hybrid work.
