State residency and moving

In short

A friend of mine once told me he would move to a no tax state the day his company sold, and he meant it like a man planning a fishing trip. If you are thinking about leaving a high tax state before a big payday, you have probably heard the same easy talk. The truth is plainer and harder. A state taxes a resident on nearly all income, wherever it was earned. A state can also tax a nonresident on income that comes from inside its borders. A move counts only if it is real, with a new home, new habits, and a clean paper trail. Dates matter a great deal, so the move should come before the income, not after. A state tax auditor looks at a life, not a mailing address. Talk to a tax professional in both states before you sign anything.

The whole of it

What it is

I once watched a neighbor argue with a tax office over a cabin he swore he never used. He lost, because the receipts told a different story. That is the heart of state residency. Each state decides for itself who counts as a resident, and the rules are not the same from one place to the next.

Most states use two tests. The first is domicile. Domicile is the place you call your permanent home, the one you plan to return to whenever you are away. A person can own many homes, but only one domicile at a time. The second test is statutory residency. Under it, a person who keeps a home in a state and spends more than a set number of days there can be treated as a resident, even if his domicile is somewhere else. Each state sets its own day count. The state tax agency publishes the actual rule, and that agency's own guidance is the place to read it.

Some states have no tax on wages at all. Others tax wages heavily. That gap is why founders and high earners think so hard about moving. It is also why the home state looks so closely at anyone who leaves.

How it works

If you are holding a stock sale, a big bonus, or a payout from a company you built, the question is simple. Which state gets to tax it, and when? A resident is generally taxed on income from all sources. A nonresident is taxed only on income sourced to that state, such as wages for work done there or rent from property there. A part year resident is taxed as a resident for part of the year and as a nonresident for the rest.

Here is where founders get surprised. I once heard a founder say his sale date was the only date on his calendar, and he was not far wrong. Each state writes its own rules for taxing a gain from stock, and many look to where the seller was domiciled when the sale happened. Some states look instead to where the business or the property sits, so the state tax agency has to be asked. Either way, the date a person changes domicile can matter a great deal. Moving a week after the sale closes does not move the tax along. Neither does moving a week before, if the state later finds the move was for show.

States look for proof of intent. They ask where a family lives, where the kids go to school, and where the doctor and the dentist are. They check where valuable keepsakes sit, where a person votes, and where the driver license and car registration come from. They may ask for credit card statements and phone records to see where someone actually spent his days. A clean break is easier to defend than a half move.

Some states also have a special rule for people who keep a permanent place to live in the old state. If a family keeps the home and just buys a condo somewhere warm, the old state will ask hard questions. Cutting ties is the cheapest way to avoid a long fight.

The numbers, and where to find yours

Your own numbers live in a few plain places. The first is the residency day count for your old state. This is the number of days that can make a person a statutory resident, and the state sets it. The state tax agency website carries it, often in the residency guidance or in the instructions for the nonresident return. The figure is the current figure, which the official source publishes each year.

The second number is the top state income tax rate in the state you are leaving and in the state you are joining. Each state publishes its rate schedule. The rate that applies to a large sale is the current figure, which the official source publishes each year, and it is worth checking for both places. Some states add a surtax on very high income, so ask whether one applies.

The third place to look is federal. A state move does not change federal income tax. The Internal Revenue Service publishes the federal rates and the rules for capital gains each year, and the long term capital gain rate that may apply is the current figure, which the official source publishes each year. Federal rules treat state tax in a limited way, because the cap on deducting state and local taxes is the current figure, which the official source publishes each year. Congress sets that cap by law, so look it up on the IRS site before planning.

Finally, keep your own record. Write down each day you spend in each state. A simple calendar works. I have seen a plain wall calendar save a man thousands of dollars in a dispute.

A worked example

Let me tell you about a woman I will call Dana. She built a software company in a made up state with a 10 percent top tax rate, picked only to keep the math easy to follow. She agreed to sell her shares for a gain of $2,000,000, and the sale was set to close in December.

In October, Dana moved to a state with no income tax. She sold her old house, bought a home in the new state, enrolled her kids in a new school, and got a new license. She also changed her voter registration and moved her doctors. She kept a calendar showing 40 days in her old state that year, well under the day count her old state uses.

Because her domicile changed before the sale closed, she planned to treat the gain as income of a resident of the new state. At a 10 percent rate, the state tax she hoped to avoid on the gain was 10 percent of $2,000,000, which is $200,000.

Now picture Dana doing it the careless way. She buys a condo in the new state but keeps her old house, her old doctors, and her old club membership. She spends 150 days at the old house. Her old state audits her and finds her family and her belongings never left. Under that audit, the state taxes the whole gain, and the bill is again 10 percent of $2,000,000, or $200,000. On top of that she may owe interest and penalties.

Notice that the move itself is the same in both stories. The difference is the proof. In the first story, Dana can show a real change in her life. In the second, she can show only a new address.

Where it goes wrong

I have known good, honest people who made this mistake, so no shame belongs here. The first trap is moving too late. If the income is already earned, the old state may still claim it. The second is a soft move. Keeping the old home, the old routines, and the old friends makes it look like the person never left.

A third trap is the day count. A person can spend a bit too long visiting the old state and cross the statutory line without noticing. That is why a calendar matters. A fourth trap is deferred income. Some payments, such as earnouts or installment payments from a sale, arrive after the move. Whether the old state still taxes them depends on that state's own rules. The seller should ask the state tax agency before assuming anything.

There is also the matter of a business. If the company still has offices, employees, or customers in the old state, some of its income may still be taxed there, no matter where the owner lives. A personal move does not erase that.

Finally, remember that the old state may simply disagree. A state is free to question a move that it thinks was made for tax reasons. The way to meet that question is with records. Neat ones help.

Questions to answer before you leave this page

Have you picked a new state where you will truly live, or just one where you want to file? Can you show a real break from the old state, such as a sold or leased home, new schools, new doctors, and a new license? Do you know the day count your old state uses, and have you kept a calendar of where you slept each night? When does the income arrive, and does your move come before that date? Does your company still have ties to the old state that could keep some income taxable there? Have you read the residency rules on the tax agency websites of both states, and have you asked a licensed tax professional to look at your plan before you act?