Eric Donner ChFC®, CExpTM, CAP®, CLU®
Business Activity Pitfalls for Change of Domicile
Updated: Mar 7, 2022
Business activities is one of the five primary factors for the Domicile Test in New York State and others. If you own a business and live in a high tax state, be aware of your future tax burden if you plan to change your domicile to a low- or no-income tax state. Better yet, if you’re planning on selling your business in the future, it’s in your best interest to mitigate your tax liability by planning ahead. If you move from a high-tax state to a low-tax state to avoid paying the higher income taxes on the sale proceeds, you must take proactive steps several years in advance to mitigate your risk.
In the past few years, more than a million high-income earners have made the move to low-tax states. Many of those that failed to properly plan their change of residence fell victim to state residency audits. If you own a business in a state like New York and plan to make a move, there’s a nearly 100% chance you’ll face a state audit.
More than half of those getting audit lose. That allowed New York to assess more than $1 billion in back taxes, penalties, and fees over a five-year period. And with the states hurting for revenue due to the deficits from Covid-19, the state tax auditors are on the prowl.
Determining Your Domicile
The burden to prove you legally changed your domicile falls on you, and the process can be extremely time-consuming and invasive.
Business Activities is one of the five primary factors state tax auditors will look at in determining your true domicile. If you own a business, they look even closer and from a variety of angles:
Pattern of involvement
If you plan on maintaining an interest or actively participating in a business in New York State, for example, auditors will weigh that against your involvement in businesses at other locations when determining domicile. Changing your residence while maintaining active participation in your NY business likely won’t be enough to avoid residency taxes.
Case law has been established that even if you’re living out of state but continue to actively work with the NY-based business, you’re working on behalf of the company and subject to New York taxes.
Even if you’ve done everything else right to establish residency in another state, failing to handle your business transition properly as defined by the state’s Department of Taxation, you’ll be at serious risk for being classified as a New York resident and subject to state taxes. And this holds true for other states as well since they all want their share of your tax bill.
Your direct involvement in the business, however, is just one of the things auditors will examine.
Activities with family members within a family-owned business can come into play here. If a parent passes on daily operations to their children and takes a reduced role, they may still be considered an active participant. Even if they significantly reduce status, title, and compensation, it may not be enough to demonstrate a change of domicile.
Plan Your Move Carefully
This doesn’t mean you can’t continue to own your business in your Home State. What it means is that a business plan combined with a domicile change strategy is required. If you’re planning on selling in the next few years, you may want to wait on your business exit until you have established a bona fide domicile in your new state.
If you’re planning to maintain your business connection, there are also steps you can take to mitigate your state tax liability. Here’s an example. Let’s say your business is in New York, but you plan to move from the high-tax state to a low-tax state, such as Florida. Your strategy might include opening an office in Florida and shifting business activities there to reduce your involvement back in New York. You may want to hire a few employees in Florida, build some business connects, join a few networking groups. This and other business activities and patterns will help set the stage. You can also set up Florida business entities and trusts and implement some creative asset shifting in preparation for your future departure from your high tax state.
However, be aware that state tax auditors will conduct a deep probe into many other facets of your life, not just your business. Business activities is only one of five primary factors. The others include Home, Family, Items near and dear and Time. When they cross reference your cell phone activities and your travel history with your business activities, it can be extremely difficult to track. This becomes really tough when the activity was two or three years ago.
However, with the right guidance and advice, you can continue to be part of your business activities and legacy, while minimizing the tax bite.
Either way, the move should be planned methodology and well in advance to mitigate your tax liability. And Six Months and a Day is here to help you. Six Months and a Day built a turnkey platform including proprietary software to identify patterns and activities that helps to develop a comprehensive strategy for a smooth business exit, business transition, or relocating your business.
We work with high-income earners and business owners to create a strategy to manage the entire domicile change process. It includes proactive planning and the creation of a personalized audit trail designed to prepare you in case of an audit. Six Months and a Day identifies the specific change factors for each client, conduct a residency audit risk assessment, and designs a customized Domicile Change Playbook to mitigate your risk.
We also offer a White Glove Concierge service that can help you manage all the tasks associated with transferring domicile from a high-income tax state.
Contact Six Months and a Day today to learn more.