What You Should Know About State Taxes and Residency While Living Abroad
Regardless of where they reside, U.S. citizens and green-card holders living outside the United States are subject to U.S. income tax on their worldwide income. However, it’s rare that U.S. expats are subject to paying state taxes, unless they didn’t properly break state residency.
As Americans living abroad, U.S. taxpayers must proactively take the necessary steps to break residency or risk being liable for taxes in their last state of residence. Because residency rules vary from state to state, it’s critical for U.S. expats to understand state residency rules and how they may impact their tax bill.
State Residency Tests
An American taxpayer will generally be considered a resident of a state if the taxpayer intends to permanently stay in that state. Most states will employ multiple tests to determine such intent. These tests are not mutually exclusive. On the contrary, they complement each other.
Presence Test
The first (and arguably more objective) test is called the presence test. A taxpayer will be treated as a resident of a state in which he or she was physically present for a certain number of days within a specific tax year. For example, in California one would have to spend an aggregate of at least nine months in California during a given tax year to be considered a resident, while in Kansas this minimum is set to six months.
However, while it’s possible to reside in a state within the limits of its requirements for the presence test, it doesn’t exclude you from potentially being liable to state taxes under the substantial presence test.
Domicile Test
The second test is the domicile test — a subjective test focused on a taxpayer’s intent, which has led to many court proceedings over the years.
In a significant 2017 ruling, the New York Division of Tax Appeals ruled that despite a man living in — and being employed in — Texas while also spending time with friends and enjoying local activities in Texas as he waited for his apartment to sell, his change in domicile was only legally determined once his dog was moved from New York to Texas.
In the case of work visas, moving abroad may become challenging to prove because of the temporary nature and employment conditions attached to such visas. For example, among the requirements provided by the State of California Franchise Tax Board, one must be under an employment-related contract for an uninterrupted period of at least 546 consecutive days and must not intend to return in California for more than 45 days during the taxable year.
Once a taxpayer’s residency status within a state is established, they’ll be subject to state taxes on their worldwide income, no matter where the income arises, although most states will allow their taxpayer to leverage tax credits to avoid being taxed in two U.S. states at once.
What is a Nonresident?
Unsurprisingly, most states define a nonresident as a person who is not a resident of their state, generally meaning they’re simply passing through or staying in the state for just a short period of time. Some states define additional categories of residency, such as part-year residents (as in the case of North Carolina). A nonresident is only subject to state taxes on the income sourced within such a state. In general, wages and other types of compensation are sourced within a state if the services giving rise to such income are performed within the state’s borders.
Specific regimes are in place for revenues such as dividends, which are sourced within a state if the company paying the dividends is a resident of such state. Certain states have concluded reciprocal agreements, allowing residents of one state to request exemption from tax withholding in the other (reciprocal) state. This saves a taxpayer the trouble of having to file multiple state tax returns.
Change of Residency for Expats
Once residency has been established in a state, it may be difficult to lose. As the burden of proof rests on the resident, the taxpayer will have to proactively take the necessary steps to break ties with their former home state. Most states require proof of a new location to demonstrate true relinquishment of state residence. The taxpayer will also have to physically reside in a new out-of-state location with the intent to permanently remain there.
How to Determine State Residency for Tax Purposes
In practice, a state will examine multiple factors to determine whether a taxpayer has truly abandoned their residency, or they’ll risk filing state taxes. Those factors will often include:
- A driver’s license
- Voter registration
- Cell phone bills
- Memberships in professional, social and religious organizations
- The location attached to professional licenses
- Where the taxpayer’s spouse and children live
- Where the taxpayer’s children attend school
- The numbers of days spent in the state
- The general purposes of the days spent in and out of the state
Accordingly, it’s important for taxpayers to examine and evaluate the above factors before claiming a residency change on their personal tax return to avoid paying state taxes while living abroad.
Taking Advantage of State Residency
Taxpayers may want to take advantage of moving to a different state before leaving the country. Currently, eight states don’t impose personal income tax.
| States With No Personal Income Tax | |
|---|---|
| Alaska | Tennessee |
| Florida | Texas |
| Nevada | Washington |
| South Dakota | Wyoming |
Conversely, living abroad may create great planning opportunities for taking advantage of Roth contributions, and even conversions, before returning to the U.S. Learn how state taxes can make Roth conversions a huge opportunity for Americans abroad.
Carefully cutting all ties with your resident state can be a difficult task that should be planned before an international move for tax efficiency. If you’re an American considering moving abroad, request a meeting with a member of our team.
