Sometimes, the decision to move from a high-income tax state like New York or New Jersey to a state that does not impose an income tax, such as Florida, is precipitated by a taxpayer receiving substantial retirement income or the vesting and/or exercising of equity options caused by a change in control event. This article narrowly outlines critical state tax considerations and potential pitfalls of relocating to Florida.
Understanding Domicile Rules
A prerequisite to analyzing the state tax treatment of income earned by a non-resident is determining whether a taxpayer has effectively changed their domicile. Domicile is where a person has his true, fixed, permanent home and principal establishment and to which they intend to return whenever they are absent.
A person may have several residences or places of abode, but they can only have one domicile. To show that a different state is a person’s new domicile, generally, it is necessary to show the physical assumption of a new home in that location, an intention to establish a new domicile in that location and an intention to abandon the old domicile.
Changing domicile from New York or New Jersey to Florida involves demonstrating a clear intent to establish Florida as a permanent home. The proper strategy includes, among other things, the taxpayer buying or leasing a substantial residence, moving to the new residence with their family, registering to vote, changing driver’s licenses and, most importantly, abandoning ties to the previous state of residency.
Domicile versus Statutory Residency
Even if a taxpayer effectively changes their domicile to Florida, they can still be considered a statutory resident of New York or New Jersey if they maintain a permanent place of abode in one of those states and, with limited exceptions, spend more than 183 days in that state during the year. Not meeting the 183-day rule will automatically cause the taxpayer to be treated as a resident instead of a non-resident for income tax purposes.
The distinction between a resident and a non-resident is crucial. Residents are taxed on their worldwide income. Non-residents pay tax only on income from the state. Proper documentation, such as credit card and telephone GPS records, utility bills and travel records, is essential; it’s a taxpayer’s burden of proof to show their whereabouts during a residency exam, and any unproven days by the taxpayer will be deemed a day spent in the former domicile.
Steps to Establish Florida Residency
To successfully change residency from New Jersey or New York to Florida, taxpayers should take the following steps:
- Sell or rent out the property located in the former domicile. Simply owning property in a taxpayer’s former domicile does not automatically make one a resident; however, maintaining significant ties to these states can. Selling or renting out the property in an arms-length lease is perhaps the strongest evidence of a taxpayer’s intent to abandon their former domicile.
- Establish strong ties in the new domicile. This includes buying or renting a Florida home that is larger or more valuable than the home in a taxpayer’s former domicile, moving their family there; registering to vote; obtaining a Florida driver’s license; joining local clubs and/or a house of worship; transferring medical care; and moving personal items and valuables to Florida.
- Document time spent in each location. It’s vital to keep meticulous records of where time is spent to ensure that less than 183 days are spent in the former domicile. The taxpayer bears the burden of proof in residency audits, so being responsible and prepared with records is crucial.
- Change mailing addresses and professional relationships. This includes the taxpayer notifying banks, brokers, accountants and other professional relationships of their new Florida address and moving their professional relationships (e.g., doctors, investment advisers, insurance agents) to Florida.
Potential Pitfalls and Audit Risks
State tax authorities are vigilant in ensuring that taxpayers who do not meet the non-resident criteria pay their share of tax, interest and penalties. Residency audits initially focus on several key factors of domicile:
- Home: What is the comparative size, value and use of homes in new versus former domicile?
- Business involvement: Is there continued involvement in a business located in the former domicile?
- Near-and-dear items: What is the location of personal items of significance, such as family heirlooms, collectibles and art?
- Family: Where do immediate family members, especially spouses and minor children, reside?
- Time: How much time is the taxpayer spending in the new versus former domicile?
If, during a state tax residency audit, a taxpayer either fails to show they effectively changed domicile or fails the 183-day statutory residency test, New York and New Jersey will generally tax all of their worldwide income, including pensions and deferred compensation such as performance-based equity compensation and change of control severance payments.
The balance of this article addresses taxation implications under the assumption that the taxpayer is deemed a non-resident for income tax purposes.
Allocation of Non-Resident Income
Income from sources within New Jersey and New York for a non-resident individual, estate or trust generally means the compensation, net profits, gains, dividends, interest and other enumerated items of income gross income to the extent that it is earned, received or acquired from sources within New Jersey and New York and is subject to state income tax at the same rates as residents.
Certain Pension and Annuity Income
The Pension Source Act prohibits states from taxing most forms of retirement income received by non-residents (e.g., all qualified plans such as pensions, IRAs, deferred compensation such as 401(k) plans and most nonqualified plans).
Stock Options and Other Performance-Based Compensation
Stock options, performance-based equity compensation and change of control payments (i.e., income triggered by a change in the ownership or control of a company) have complex tax implications well beyond the limited information contained in this article but are briefly summarized below:
- For New York income tax purposes, a non-resident’s income from stock options, stock appreciation rights and restricted stock is sourced to New York using a grant-to-vest method based on the taxpayer’s workday allocation factors for the years between the date on which the options or stock was granted and the date on which the options or restricted stock vested.
- For New Jersey income tax purposes, a non-resident has New Jersey source income from compensation received from stock options, stock appreciation rights or restricted stock if, at any time during the allocation period, the non-resident individual worked in New Jersey or performed services in New Jersey for the employer (grantor) granting such options, rights or stock. The allocation period is defined as the taxpayer’s workday allocation factors between the date the options were granted and the date on which the options were exercised.
Change-of-control payments to non-residents resulting from mergers, acquisitions or other corporate restructuring events may be subject to New York or New Jersey income tax if the services related to the payment were performed in those states. Change-of-control payments present unique tax challenges for those moving to Florida from New York or New Jersey and require a careful review of the plan documents to determine the appropriate allocation of income.
Relocating to Florida (or other states with lower or no state income tax) offers a unique opportunity for substantial savings but requires careful planning to avoid potential tax liabilities stemming from a taxpayer’s former residence in a high-tax state during their employment. Understanding the rules regarding domicile, statutory residency and non-resident taxation of retirement income, the vesting and/or exercising of performance-based equity compensation or change-in-control payments is critical.