Back in March, when the COVID-19 pandemic began to rage in the northeast, people who had the means and ability left highly populated cities and “temporarily” moved to less congested neighboring states. Many of these people had second homes in these neighboring states. While most people thought the move out-of-state was going to be temporary, four months later many people are seriously considering staying where they are for the remainder of the year. Since historically most of these people never spent more than 30-60 days in a given year in their second home, the thought of being required to pay state income tax to two states as a resident was never considered – until now.
The terms “domicile” and “statutory residence” are often used synonymously. However, for state tax purposes, the two terms have distinctly different meanings.
The term domicile equates to the location of one’s true home. Thus, a taxpayer can only have one domicile at a time. Once an individual establishes a domicile, that location will remain his/her domicile until the person can show with “clear and convincing evidence” he/she intended to both give up their old domicile and establish a new domicile.
Most states consider an individual who is domiciled in another state to be a “statutory resident” for income tax purposes (which means subject to tax on one’s worldwide income as if domiciled in the state) if the individual:
Individuals are considered statutory residents for an entire tax year if the person meets the 184-day test at any point in the tax year. Therefore, an individual can be a domiciliary of a state AND be a statutory resident of another state during the same tax year. This is typically referred to as being a “dual resident.”
Regardless of whether being classified as a domiciliary or a statutory resident, the tax ramifications are generally the same: the state will tax 100 percent of an individual’s worldwide income (i.e., federal taxable income with certain modifications). In order to avoid double taxing all of a dual resident’s income, most states provide a credit against its tax for taxes paid to other states on income earned in that state. Unfortunately, the credit mechanism many states use does not prevent the double taxation of certain income like interest, dividends, capital gains, and certain income from pass-through entities (i.e., partnership and S Corporations).
By way of example – Individual A is domiciled in New York State and has a vacation home in Vermont, which she historically used during the winter. When the pandemic hit New York in early March, Individual A left her New York home and moved into her Vermont home until things quieted down. Individual A is now considering spending the remainder of the year in Vermont and may not return to her New York home until sometime in 2021.
Individual A should consider the following:
August 25th will be her 184th day in Vermont. In addition to the time spent in Vermont during the pandemic, she also spent two weeks there in January, skiing. Therefore, given Individual A has a home in Vermont and if she decides to stay in the State past August 25th, Vermont will tax her as a statutory resident for all of 2020 regardless of whether she ends up going back to New York at any point after the 25th of August. In addition, since New York is Individual A’s domicile, New York will also tax her as a full-year resident.
Assume Individual A earned $100,000 while working in New York at the beginning of 2020 and $50,000 of interest and dividends on her investments during the course of the entire year. As a dual resident of Vermont and New York, Individual A would owe Vermont and New York income tax on her total income of $150,000 and be entitled to a credit against her Vermont taxes for taxes paid to New York attributable to the income she earned in New York (i.e., $100,000). However, no credit is available for the taxes Individual A pays to both states on the interest and dividends she earned during the year. This could equate to an effective state tax rate of approximately 15 percent on her investment income.
Immediately count the number of days (any part of a day equates to a “day” for this purpose) during 2020 that you have been at your historical second home. If you are still under 184 days, you have a choice: (1) you can go back to your state of domicile and avoid the potential dual resident issues; or (2) you can consult with your tax advisor as soon as possible to understand the potential additional tax cost of being considered a dual resident.