Second home, different taxes?

Gaining a new residence can mean a big change in your tax bill — up or down... but you need to know whether your move qualifies as a change of residency for tax purposes.

If you have moved recently or are planning a move, you’re among the roughly 35 million Americans annually who change their place of residence. And if that move crosses state lines, you might find yourself facing a very different income tax bill.

“Where you end up paying state taxes could make a big financial difference for individuals with a high amount of taxable income,” says Richard Scarpelli, executive director and head of financial planning at UBS Financial Services.

For example, a high-income earner in California (the state with the highest tax) can pay as much as 13.3 percent, while that same earner would pay 0 percent in Nevada, one of seven states with no income tax at all.

Given such disparities, it’s no surprise that for people with the flexibility to choose where they live, the search for lower taxes often plays a big role in that decision, Scarpelli notes. But qualifying as a resident of a new state for tax purposes may not be as simple as buying a home – especially if you plan to hold on to a home in your previous state.

Here are tips to help you make a smooth transfer of residency when relocating to a new state:

• Maintain employment, bank and telephone records, and other paperwork to document the time you’ve spent in your new state.

• Be sure to speak with your tax professional before making any tax decisions.

• Speak with your financial adviser about how taxes fit into your overall wealth plan.

Be prepared to prove your case

States’ definitions of “residence” for tax purposes vary widely, but typically they’re based on your actions.

“States will look at evidence to gauge your circumstances and intent,” says Scarpelli. “So the more evidence you present for residing in a particular state and your intention to stay there, the stronger your case will be.”

Many states don’t accept a taxpayer’s testimony, considering that it is likely self-serving, so you will probably need documentation.

Aside from buying or selling real estate, typical actions that help establish state of residence include: • Enrolling children in local schools. • Directing all federal tax returns, correspondence and financial-related mail to your new address.

• Terminating old voter registrations and registering to vote in your new state.

• Engaging a local doctor and dentist and moving medical records to their offices.

• Preparing new estate planning documents (will, trust, power of attorney) in accordance with your new state’s laws.

• Changing your vehicle registration and insurance and obtaining a driver’s license in your new state.

Even with these steps, states are often reluctant to let high income tax payers go and may perform an audit to determine how much time you spend in the state you are potentially trying to divorce yourself from. You should work with a tax adviser to arm yourself with the knowledge to make an informed decision as each state may have a unique set of rules.

Auditors have begun requesting more information to support change-of-residency claims, so after a move, make a point to keep the following records in case of an audit: • Credit card statements and receipts • Bank records, including ATM receipts • Freeway fast-lane pass and toll road charges • Telephone records • Employment records • Calendars and diaries

Collecting this documentation might seem burdensome, but the effort will be worth it if it helps you avoid the extra taxes, interest and penalties associated with a failed audit.

“It’s really important not to just look at the tax issue in a silo. Wherever you move, you also need to make sure you will be comfortable and happy,” Scarpelli noted.

Remember the big picture

State income taxes are just one piece of your overall financial picture. If you have to relocate to a higher-tax state for a new job or other life change, your accountant and financial adviser can examine strategies that might mitigate the impact of those higher taxes. Likewise, before moving to a low-tax state with an eye toward reducing your tax bill, ask your advisor to examine the potential benefits of that move in the context of your personal goals and overall financial and tax circumstances. While a lower tax rate might seem enticing, note that other elements will likely affect your happiness, as well as your financial situation, far more, including commuting, schools, distance to family and other external factors.

“It’s really important not to just look at the tax issue in a silo,” says Scarpelli. “Wherever you move, you also need to make sure you will be comfortable and happy.”

Key takeaways

• Differences in state income tax rates are a major incentive for many people to relocate.

• Residency requirements for tax purposes involve more than just owning real estate.

• Registering children in local schools and changing your driver’s license, voter registration and key estate planning documents can help prove residency in a new state.

• Your previous state may conduct an audit to determine whether you still owe taxes there.