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New York: Reaching out to Tax Everybody
A recent and controversial decision from the New York Court of Appeals, the highest court in New York, illustrates how desperate the state is to tax everybody on everything, even non-residents. The Court said that New York could impose full income tax on a Tennessee resident's wages from New York, even though he "telecommuted" to his New York employer and was rarely in New York. The case is Huckaby v. NY State Division of Tax Appeals.
This case underscores the critical issues of state "residency" for both active workers and retirees who move to the sunbelt but keep some contacts --- personal, business, or financial --- in high tax New York. While the case does not deal with a retiree, it demonstrates how far New York will go to tax even bona fide non-residents who spend little time in the state.
Being a "non-resident" of New York is not a safe haven from its income taxes. This new case makes it even less safe.
I get many questions from clients about "residency." What can they do to escape New York income and estate taxes if they move out of the state? When do they cease being a tax resident? What taxes can New York impose on a non-resident?
In this memo let's take a look at the basic rules of state residency requirements on taxation.
Background "Residency" is a confusing subject and a great deal of misinformation exists. Every retiree on a Florida shuffleboard court is a self-proclaimed "expert" on how to become a Florida resident. As clients migrate out of the northeast rust belt to the warmth and lower taxes of the sunbelt, they want to establish "residency" in their new state. Their big concerns, of course, are state income taxes and state death taxes. Which state can tax your income? Which state can tax your estate at death? The answers are not always clear, as many clients maintain homes, work, and spend time in more than one state. We'll be seeing much more of this as the baby boomers retire and technology allows business to be conducted over the internet.
Terminology Trap Be careful of the terminology trap. Think of Abbott and Costello's classic routine, "Who's on First?" which breaks down to absurdity when people use words that mean different things to each other. The same trap applies to the term "resident," as it has several different meanings in different contexts.
If you move to a new state, you can likely qualify as a "resident" in thirty days or less to vote, get a driver's license, or get a library card. However, you may have to live in your new state for six months to qualify as a "resident" to get divorced or adopt a child. You may have to live in your new state a full year to be a "resident" for lower tuition at the state university. So, you can be a "resident" motorist, voter, and library patron, but a non-resident if you seek a divorce or attend the state college. Compounding the confusion are fifty separate states, each with their own definitions of "resident" for each of these purposes.
Tax "Residency" Our clients' questions about "residency" in the new state are almost always about taxes, not library cards. In the context of state taxes, "residency" is more complex and requires an understanding of "domicile."
Your "domicile" is the one state, to the exclusion of all others, that is your "permanent home." Only one state can be your "domicile." You may be a "resident" of several states for various purposes, but you can be a "domiciliary" of only one. To be a domiciliary of a state requires (i) your presence in that state, and (ii) your intention to live permanently in that state. As you might expect, the demonstration of your intent is critical. Where you work, vote, maintain a driver's license, register your car, go to church, and pay taxes demonstrate your intention and determine your domicile. You cannot establish a domicile in your new state until you terminate your domicile in the state you left.
Estate Taxes Domicile is a key issue for state estate taxes. Many states impose their own estate taxes. Again, watch out for the terminology trap. In the context of state death taxes, the terms "residency" and "domicile" are sometimes used interchangeably. A state can impose its estate tax on the world wide tangible and intangible assets of a deceased domiciliary. If you are a domiciliary of New York who owns land in South America and a bank account in North Carolina, New York will tax both at your death.
With respect to a deceased non-resident (or non-domiciliary), a state can tax only the tangible personal property and real estate of that person within the state. The New York brokerage account (an intangible) of a North Carolina decedent will be taxed by North Carolina, not New York. With the reduction of the federal estate tax, state estate taxes are drawing the attention of more clients. Many clients in New York, which has a high estate tax, want to become "residents" of Florida or South Carolina, which effectively have no state estate tax.
Many clients form family limited partnerships or family LLCs to hold real estate located in states other than those in which they reside. By doing so they convert their real estate in that other state into an intangible asset (the interest in the partnership or LLC), so that at death there is no estate tax in that other state.
Income Taxes Residency drives state income taxation. Generally speaking, if you are a resident of a state, it can tax your world wide income. If you are not a resident of a state, it can tax only your income from that state. New York has a comprehensive scheme for determining "residency" for income taxes.
In New York, you are a tax resident if (i) you are domiciled in New York, or (ii) you have a "permanent place of abode" in New York and spend more than 183 days in New York. This latter designation is knows as a "statutory resident." There are voluminous regulations, guidelines, and cases that explain the nuances of these residency tests. New York has always been aggressive in asserting residency.
New York can tax a non-resident only on his New York source income. This is where things get a bit more dicey and where Mr. Huckaby got into hot water. New York source income includes income from real or tangible personal property in New York, services performed in New York, and income from a trade, profession, or occupation carried on in New York. So, if I live in Florida but I have income from my law practice in New York, I owe New York tax on that income. That is certainly fair.
The New York tax regulations say that if a non-resident has income from his employer for services performed both in and outside of New York, he owes income tax to New York in proportion to the days spent in New York. That makes sense. But, the regulations take one more step, the step that caught Mr. Huckaby.
"However, any allowance claimed for days worked outside New York State must be based upon the performance of services which of necessity, as distinguished from convenience, obligate the employee to out-of-state duties in the service of his employer."
This is the "convenience of the employer" rule. If a non-resident with New York services income is out of the state when performing those services for his own convenience, not the employer's necessity, all services income will be treated as being from New York sources and therefore taxed. There is no apportionment between the states in that case.
In Huckaby v. NY Division of Tax Appeals, decided by a 4 to 3 vote on March 29, 2005, New York successfully taxed the full services income of a Tennessee resident from his New York employer even though he was in New York only 56 days during one year and 62 days the next year. Mr. Huckaby was a "telecommuter." He was a computer programmer who worked from his Tennessee home, 900 miles from his New York employer. He traveled to New York only when requested by his employer. Since he spent only about 25% of his working time in New York, he paid New York income tax on 25% of his income from his New York employer. But, the New York courts held that he should pay tax on 100% of the income from his New York employer, because he lived in Tennessee for his personal convenience, and not "the convenience of the employer." It is said that New York's "convenience of the employer" standard for imposing income tax on all wages paid by New York employers to non-residents brings in about $100 million of taxes per year. Don't expect New York to cave in on its "convenience of the employer rule" any time soon.
This decision is not the final word. The case may be appealed to the U.S. Supreme Court. Other cases are in the pipeline and federal legislation may change the rule. Stay tuned.
Conclusion New Yorkers who move to other states must be aware of the long arm of the New York State Tax Department. Given the financial desperation of New York, and its insatiable appetite for more tax revenue, it will continue to grab taxes from bona fide non-residents. Non-residency is not necessarily a total safe harbor from the New York tax collector.