Updated June 22, 2023
In the age of telecommuting and hybrid work, many employees may work in one state, but spend significant time in another. Figuring out legal residency can be complicated, but it is important to understand how to establish residency for state tax purposes.
For example, consider “Pihla,” who is a long-time resident of Virginia. She works as an attorney at a large global law firm headquartered in Washington D.C. Normally, she works from her law firm’s D.C. Office, but last year she was assigned to a case in her firm’s New York City office. To complicate matters, she works out of her second home in Florida during the winter and spring months.
Taxpayers like Pihla are quite common today as telecommuting continues to be a normal part of the corporate work environment. How do we determine the state of residency for Pihla?
Tax Home – Domicile and Residence
There are two tests to determine a taxpayer’s tax home – the domicile test and the statutory residency test. For tax purposes, it is important to understand the difference between a “domicile” and a “residence.”
A domicile is a person’s permanent home. A domicile is the place where a person intends to return, the place of the person’s true, fixed, and permanent home. This is evidenced by various facts and circumstances, such as where the person owns a physical primary home or does business; how much time a person spends there; where a person keeps personal belongings and pets; or where the person’s family lives. A person can have a domicile different from their residence. For example, a member of the military could spend an entire year outside their domicile due to a military order. Or a U.S. expatriate may reside in a foreign country for a secondment for a year or two, while remaining a domiciliary of their home state within the U.S. The state where you are domiciled is your “home state.”
A residence, on the other hand, may be established by a statutory test. Each state has different rules on this. A statutory residence rule is usually based on the amount of time that a person has physically spent in that state – often 183 days or more (half a year plus one day). An individual can only have one state of domicile but can be a resident in more than one state.
In Pihla’s case, her domicile is Virginia because her primary home is there, she keeps most of her belongings there, and her family is there – she considers Virginia her home state where she would always return. But she may be a resident of Virginia and Florida for tax purposes if she was physically present in Florida for more than 183 days while domiciled in Virginia.
How to Establish a Domicile in a New State
A person can only have one domicile at a time and must establish a new domicile in order to change her domicile. While there is a statutory residency rule that determines tax residency based on certain mechanical requirements (such as the day count of physical presence in that state), tax residency based on the domicile test is usually dependent on the facts and circumstances. Recommended steps to establish and document your domicile include:
- Keep records supporting the day count (days you were physically present) in the state, including evidence such as:
- Credit card transactions (statements)
- ATM usage
- Personal diary/journal, calendar records
- Travel records (flights, EZ pass, etc.)
- Phone records – landline, cell phone records
- Smart phone apps tracking locations
- Get a driver’s license in the new state and register your car there.
- Register to vote in the new state. Obtain local a library card.
- Open and use bank accounts in the new state. Close accounts in the old state.
- File a resident income tax return in the new state, if it’s required. File a nonresident return or no return (whichever is appropriate) in the old state.
- Buy or lease a residence in the new state and sell your residence in the old state or rent it out at market rates to an unrelated party.
- Change your mailing address on important documents, such as passports, insurance policies, and wills or living trusts.
Statutory Residency
An individual who does not intend to relocate permanently could still be treated as a “resident” under that state’s statutory residency test. A statutory residency test normally looks at a person’s physical presence. For example, in Minnesota, a person will be considered a resident if they spend 183 days or more in the state and they have an abode in Minnesota, even if they intend to return to another state in a set amount of time. For calculating days in-state, any time spent in the state, even if it’s one minute, can count as a day.
In Pihla’s case, her W-2 may list Virginia and New York with income tax withholdings for each state. Depending on how much time she physically resided in Florida, she may be able to claim herself as a Florida resident and file part-year or nonresident returns with Virginia and New York.
State Tax Obligations – Location, Location, Location
State income tax issues may arise in any state where a taxpayer resides, where they work, or where they are domiciled. As a result, a telecommuting taxpayer could have tax obligations within multiple states. Navigating this issue should begin with the following questions:
- Which state is the taxpayer’s domicile (home state)? A taxpayer always has tax obligations with their home state. However, there may be a tax relief for a person who is outside her domiciliary state under certain circumstances, such as an employment contract deploying the person outside the state for fixed time period (as in the California Safe Harbor rule).
- If the taxpayer physically resides in another state other than their home state, are they physically residing in the other state long enough to create income tax obligations with that state?
- If the taxpayer earns income from multiple states, can a state where the taxpayer was not physically present subject the income to that state income tax? (See “Convenience of the Employer Rule” below.)
An individual who is a permanent remote worker will have income tax obligations in their state of residence. If this is not the same state as their employer, or if they reside in more than one state during the year, the person’s W-2 will list more than one state. In this case, the wage earner needs to determine which state is their home state for filing taxes (this may be both, depending on the intent), and file a nonresident return with the states other than the home state. Or, the taxpayer could file two part-year resident returns with each state they resided, with the intent to make one their permanent home (domicile). In addition, a taxpayer with a multi-state W-2 should examine the state wage allocation and tax withholdings to make sure the employer correctly calculated them.
Convenience of the Employer Rule
One of the most common issues in state residency arises when states have different rules to determine income tax. In many states, a nonresident employee’s wage income is subject to tax in that employee’s state of residency. However, a few states (notably New York) determine whether wage income is subject to additional tax based on the “Convenience of the Employer” rule.
Under the “Convenience of the Employer” rule (“Convenience Rule”), a taxpayer/worker may be required to pay income taxes where their employer’s office is located. A nonresident’s wages would be subject to income tax in a convenience rule state when the nonresident taxpayer earns wages from the location of their assigned office. This applies even when all the work is actually done from the taxpayer’s home office that is outside the state of the assigned location. For example, a remote employee living in Rhode Island who works for a New York City office may be required to file New York State taxes.
At the time of this writing, states that have the Convenience of Employer rule include Delaware, Nebraska, New York, and Pennsylvania. Some states have a modified convenience rule. Connecticut uses the convenience rule only if the state of the employer has similar tax laws. Massachusetts temporarily employed the convenience rule during the pandemic period.
State Residency Issues: COVID and Reciprocity Agreements
During the COVID-19 lockdown and peak pandemic periods, there were travel restrictions and stay-at-home orders. As a result, a number of states issued a temporary relief that would exempt a taxpayer from being subject to tax where the taxpayer was physically present due to the pandemic. However, such relief was temporary during the pandemic and is no longer applicable in most states.
To reduce the tax burden on taxpayers who commute to work in neighboring states, several states have reciprocity agreements. For example, Maryland has reciprocal agreements with Pennsylvania, Virginia, West Virginia, and the District of Columbia. Under such agreements, a taxpayer could claim a refund from the reciprocal state if their employer withheld tax for one of the reciprocal states.
GRF Can Help
As we continue to see the trends of telecommuting and digital nomads, it is critical to understand the issue of state tax and residency to minimize tax liability exposures and mitigate potential negative tax implications. Be sure to contact your tax preparer for help, or contact the GRF Tax Team for assistance.
Updated content. Originally published on April 25, 2017.
