Consider the following scenario. I am not planning this anytime soon, but possibly in the future.
I am about to retire from North Carolina (top individual tax rate 7+%) to New York (top individual tax rate even higher.) I want to convert my traditional IRA's to Roth's to beat the state income tax, and want to minimize the federal tax also.
On December 30 I move to Florida (no state income tax). On December
31 I convert half my IRA, then on January 1 I convert the other half, paying Federal income tax on half in each year. On January 2 I move to New York.
OK this is nakedly obvious and would almost surely be disallowed. But what facts and circumstances would make it acceptable? I own a condo in Florida that I used to use as my primary residence and now rent out. Is it more convincing if I am living in Florida in a home I own? If I move my furniture there? Register to vote? I know I can't just be physically present for a few days when I have a domicile elsewhere, but what if I have no other actual home, no place I own or lease? Is there a minimum time period that is a rule of thumb for establishing residency for tax purposes?
A few years ago, before moving from Florida to North Carolina, I did carefully do a Roth conversion just before moving out of Florida.
Just so you know: For 2010 only, any Roth conversion in 2010 allows you to "elect" to include 50% of the income in 2011 and 50% of the income in
2012. More on this later.
The expert on this board on this subject is Katie Jaques. A search of her replies to questions on residency will get lots of hits.
That said, let's get one item out of the way. Even if NC does not tax your conversion income, the method used by NC to tax a part-year or nonresident is what I call the what-if method. You compute your federal tax and then you compute your state tax as if you were a resident the whole year. Then you use the ratio of NC Income to Federal Income to establish the ratio to apply to the what-if tax. Essentially, the taxable income from any conversion to a Roth will be used to compute your state tax rate.
If you are going to have an issue on state taxes, it will be with NC, not NY. Until you establish your new domicile or residency in NY, any income from the Roth conversion could not be taxed by NY. (Be aware that I believe NY also uses the what-if method for computing tax for part-year residents. As such, your NY tax rate would be based on income that included the Roth conversion.)
This brings us to whether NC would treat you as a resident for purposes of taxing your conversion that takes place while residing in FL. This is going to depend upon whether NC will insist that your domicile remained in NC until you established a new domicile in NY. Below is an excerpt from NC law on the meaning of domicile and what happens when you change domicile. I believe the sticking point with NC would be that your move to FL was a sham as you had no intention to change your domicile to your vacation home. You intended to change your domicile to NY and your stay in FL was for a temporary or transitory period. As such, you remained a NC domiciliary. It would certainly help if you perform all the acts mentioned below to change your domicile to FL. This would also mean, that you would have to repeat those acts again when you relocate to NY. In addition, NC may want to know what event triggered your change of domicile from FL to NY after such a short period of you changing your permanent home to FL.
======================================================================17 NCAC 06B .3901 DEFINITION OF RESIDENT (a) Only One Domicile. -- Domicile means the place where an individual has a true, fixed permanent home and principal establishment, and to which place, whenever absent, the individual has the intention of returning. In many cases, a determination must be made as to when or whether a domicile has been abandoned. A long standing principle in tax administration, repeatedly upheld by the courts, is that an individual can have but one domicile; and, once established, it is not legally abandoned until a new one is established. A taxpayer may have several places of abode in a year, but at no time can an individual have more than one domicile. A mere intent or desire to make a change in domicile is not enough; voluntary and positive action must be taken.
(b) Factors. -- Some of the tests or factors to be considered in determining the legal residence of an individual for income tax purposes are as follows: (1) Place of birth of the taxpayer, the taxpayer's spouse, and the taxpayer's children. (2) Permanent residence of the taxpayer's parents. (3) Family connections and close friends. (4) Address used for federal tax returns, military purposes, passports, driver's license, vehicle registrations, insurance policies, professional licenses or certificates, subscriptions for newspapers, magazines, and other publications, and monthly statements for credit cards, utilities, bank accounts, loans, insurance, or any other bill or item that requires a response. (5) Civic ties, such as church membership, club membership, or lodge membership. (6) Professional ties, such as licensure by a licensing agency or membership in a business association. (7) Payment of state income taxes. (8) Place of employment or, if self-employed, place where business is conducted. (9) Location of healthcare providers, such as doctors, dentists, veterinarians, and pharmacists. (10) Voter registration and ballots cast, whether in person or by absentee ballot. (11) Occasional visits or spending one's leave "at home" if a member of the armed services. (12) Ownership of a home, insuring a home as a primary residence, or deferring gain on the sale of a home as a primary residence. (13) Location of pets. (14) Attendance of the taxpayer or the taxpayer's children at State supported colleges or universities on a basis of residence--taking advantage of lower tuition fees. (15) Location of activities for everyday "hometown" living, such as grocery shopping, haircuts, video rentals, dry cleaning, fueling vehicles, and automated banking transactions. (16) Utility usage, including electricity, gas, telecommunications, and cable television.
(c) When Change Occurs. -- The following events indicate a change in residency: (1) Selling a house and buying a new one. (2) Directing the U.S. Postal Service to forward mail to a new address. (3) Notifying senders of statements, bills, subscriptions, and similar items of a new address. (4) Transferring family medical records to a new healthcare provider. (5) Registering a vehicle in a new jurisdiction. (6) Transferring memberships for church, a health club, a lodge, or a similar activity. (7) Applying for professional certifications in a new jurisdiction. ====================================================================== I am not sure what happens when a taxpayer who makes a conversion in
2010 and elects to spread the income to 2011 & 2012 changes state residency in the interim. As this type of income is intangible income, e.g., its not deferred wages, I suspect that the state in which you reside in 2011 and 2012 will want to tax it. And... I assume it is considered income on the last day of the year, so it is the state where you are residing at 12/31/11 and 12/31/12 that would tax it.
As you are relocating to NY and want to avoid paying NY tax, it probably doesn't make sense to spread the income to 2011 and 2012 and pay NY taxes. This is a financial calculation you can perform based on the time value of money and the delta in tax rates.
Thank you. What you said is about what I would have expected.
As it happens, I own a condo in Florida. If it happened to not be rented at the time I was doing all this, it would probably be more convincing if I moved into it.
I would almost surely need more of an abode than a hotel room, and have to stay more than two days. The more of the "permanent moving" acts I take - change drivers' license, mail delivery, etc. the more convincing it would be.
In the year I moved from Florida to New York, it's doubtful New York would have much claim on anything if I did the conversion before taking any steps to relocate. Mostly, it sounds like I would have to convincingly sever ties with North Carolina, like having my lease expire and moving my furniture, establishing that I have left and have no intent to return.
I've always wondered about the "what if" method, since it seems like an unconstitutional taxation by one state of income earned in another. I understand the idea behind it. However, it would seem that could be accomplished equally effectively by pro-rating deductions, exemptions, AND the tax table. If you live in North Carolina for one month and North Carolina taxes the first $24,000 of income at 5%, then you would be taxed at 5% on the first $2,000. It doesn't seem your tax obligation to North Carolina should in any way be dependent on what you make in another state. But I'm sure that's been litigated by now.
If the "what-if" method is similar to California's method (I think it is), please understand that the taxpayer's world-wide taxable income is used only to calculate the tax RATE. The only income this rate is applied to is the income from that state. North Carolina, I presume, taxes high-income taxpayers at a higher marginal rate than low-income taxpayers.
It's an artifact of having a progressive tax system. Suppose Peter Poorboy and Bill Gates both have $1,000 of taxable income from another state -- does it make sense that they should both pay exactly the same amount of tax on that?
Interesting, I looked up the mental health services tax of 1% on tax over $1 million. CA's top rate 10.55% with the mental health services tax for residents.
But the extra 1% doesn't apply to non-residents. Per the instructions for form 540, if you're a non-resident and make say $1B a year from sources outside CA, and have $1000 of CA source income, that $1000 is taxed at like 9.55%, not 10.55%.
It's possible that the progressive tax structure causes income disparities over time.
form 540NR shows that you do in fact add the mental health tax in as part of your total NR tax. See form 540NR line 72. The instructions also state: Line 72 - Mental Health Services Tax
If your taxable income or nonresident CA source taxable income is more than $1,000,000, compute the Mental Health Services tax below using whole dollars only:
No, I agree with the point about progressive rates. I assume we're talking here about a part-year resident. If Bill Gates and Peter Poorboy both lived in Iowa for one month and made $1,000, then moved to Washington State (assuming both states have an income tax) and in the last 11 months of the year Bill made $50 million and Peter made $500, yes, I think they should both pay the same tax TO IOWA.
Why should Iowa get any more or less money because of what they did at another time in the year, living, working, and earning money in another state?
Let's look at it another way. Let's say a particular minor league baseball player (I have to use a minor leaguer because most major leaguers will hit the top tax bracket regardless) starts the year in the minors and plays a 3-game series in Athens, GA. He is now alternatively (a) promoted to the majors, plays for the White Sox in the American League, makes $1 million for the year but never plays again in Georgia or (b) is cut, and starts selling used cars in Birmingham, AL.
Why should Georgia tax him more for his 3-game series in Athens in scenario (a) than (b)? He had no further contact of any kind with Georgia, he did not live there. Surely Illinois should tax him more in scenario (a) than Alabama does in scenario (b). But what has this got to do with Georgia?
I continue to contend that as a non-resident or part-year resident, your taxes to that state should be based solely on your contact with that state. Again, the deductions/exemptions and tax brackets could be pro-rated, that would be fair.
Only the CA source taxable income counts. On my tax program I created a person who made $2M out of state and $400,000 in state. There was no mental services tax. But when the person made $2M in CA, there was plenty of the mental services tax.
It makes sense to an extent. Say you live in Bay Area and make 60k a year and live there 9 months of the year. All of your salary goes to pay your living expenses. Then you move to GA and make 24k a year and live the same lifestyle. Yet your 6k of GA income is taxed at a higher rate because of your high income in the Bay Area. But then again, it's not like you're rich. The 45k earned in the Bay Area went towards the high rents, gas prices, and slightly higher food prices.
On the 1040-NR form, your US tax rate depends only on your US source income. Even if you make 1B in foreign countries and have 1000 of rental income, that 1000 is taxed at 10%.
On Aug 20, 9:22 am, Hank Youngerman wrote: [Snip example of two different scenarios: One where income goes up and one where it doesn't]
I agree with the general philosophy of this comment, but think it would likely be a rule-making and computational nightmare. For various good and (mostly?) bad reasons, a lot of the items that go into the tax computation have phase-outs and other extremely complicated calculations behind them. It would seem to me that the rule-making and instructions for figuring out how to pro-rate ALL of those various provisions of the tax code would be horrendous and probably also error-prone.
I would guess, then, that one reason for doing the calculation using all income and then pro-rating based on the income ratio is because you only have to apply the ratio in one step, instead of having to generate your own custom deduction, exemption, tax table bracket and multitudinous phase-out allocations. So, given that most tax returns are not part-year resident or non-resident returns, I would think simplicity would win out over being more precise about the calculation.
Why does it have to be this complicated? The pro-rating (as well as tax) could only consider income from that state. In other words, the line of CA 540-NR that states federal AGI would completely vanish, and all references to it would vanish too.
It's basically up to the states to determine how they tax your income. However, if we can find a way in which the CA method of taxing your income (ie. using a higher tax rate if your federal AGI is higher) violates some well established federal principle just as interstate commerce, then maybe there's a chance of getting the method repealed.
"It has long been an established rule that states may use nontaxable out-of-state assets as the measure of the state tax imposed. (See Great Atlantic & Pacific Tea Co. v. Grosjean (1937) 301 U.S. 412 [81 L.Ed.
1193]; Maxwell v. Bugbee (1919) 250 U.S. 525 [63 L.Ed. 1124].) Therefore, use of income from outside of the state to calculate the rate of tax on a taxpayer's California income is not unconstitutional."
"California's progressive rate structure is based on the concept of "ability to pay." Individuals with higher income pay tax at a higher rate than low-income individuals. The fundamental fairness of such a rate structure was explained in Brady v. New York (1992) 80 N.Y.2d 596,
605 [607 N.E.2d 1060], certiorari denied (1993) 509 U.S. 905 [125 L.Ed.2d 692; 113 S.Ct. 2998]. The Court reasoned that similarly situated taxpayers were those with the same total income. [...]
"The Brady Court concluded that the taxpayer's real quarrel was with the graduated tax. A graduated or progressive taxation system apportions the tax burden based on ability to pay. Because higher income taxpayers can pay more, they are therefore taxed at a higher rate than lower income taxpayers. (Also, see United States v. State of Kansas (10th Cir. 1987)
810 F.2d 935, affirming (D.Kan. 1984) 580 F.Supp. 512, 515; Appeal of Dennis L. Boone, 93-SBE-015, October 28, 1993.)"
I don't think that anything would be a "computational nightmare." You already have to allocate income and deductions, unless I'm badly mistaken. If I make $50,000 this year in North Carolina, then move to South Carolina, make $50,000 there, but buy a house there, I don't think I can allocate any of the mortgage interest and property taxes as deductions against my North Carolina income.
However, it seems clear that this issue has been litigated. It also seems like the "Bad cases make bad law" dictum was observed here. The case seemed to hinge on the progressive tax system, not the allocation of income across state borders. I rather assumed it had been litigated, because it seemed like a pretty obvious thing to me to raise, unless it had been litigated and settled.
I still disagree, but that's my privilege. Don't worry, Wesley Snipes and I won't be sharing a cell anytime soon.
The method makes the allocation for you as NC uses your federal taxable income as the starting point. Federal taxable income is after you have already taken "all" your itemized deductions regardless of source. So your NC taxable income before the final computation based on sourcing, has included your non NC deductions (in your example, the SC mortgage interest and property taxes).
The final allocation is the ratio of NC sourced Gross Income over Federal Gross Income. Then the NC tax rates are applied. Then you apply credits.
Effectively, NC doesn't care where you incur your deductions. You get to use them. They have opted to use a Gross Income ratio to do the pro-rationing for you. One might argue that this method benefits those individuals whose majority of deductions are sourced in some other state to the detriment of those individuals who have most of their deductions in NC.
Some other states use a "what-if I was a resident method" that differs from NC. CA, for example, uses a what-if method that is designed to maximize income to the state by pushing you into the highest tax bracket possible.
Regardless of the state, the what-if method is designed "primarily" to accomplish one goal: maximize income to the state. As long as you are only paying tax on some form of your source income, no federal law is violated. It doesn't matter that the method may force you into a higher tax bracket than some other method.
Let's all remember, if states wanted a simple method to tax your income, there are lots of methods out there that can be handled on a postcard sized form.
So sorry, guys -- obviously I haven't been checking in here lately. Long story. Anyway, y'all have handled the issues quite adequately. I'm just here to chime in.
As to Hank's original plot: Alan has it right. NY would have no claim on the income because Hank's hypothetical taxpayer would have had no connection with NY at the time the transaction occurred. (We'll get to the inclusion of the conversion income in the calculation of the NY tax rate applied to the taxpayer's income on a part-year resident return in a minute.) NC is the state he needs to worry about. NC defines a resident to include all persons domiciled in the state, and one's domicile does not change until one establishes a new one elsewhere. Moving to Florida for such a short time would never pass muster as a change of domicile. In order to change domicile, generally a person must take all of three steps: (1) move away from the previous domicile; (2) move to and reside in a new location; and (3) intend to reside in the new location permanently or indefinitely.
Intent, of course, is not always easy to prove, and state tax authorities and courts generally tend to look to the taxpayer's actions to determine it. Of course, one might move to another state with the intention of remaining there permanently and then have an unforeseen event occur that forces the individual to move back to the previous state of domicile or to a new location. You'd have to come up with a pretty good story, though, and it would have to be a significant event that caused you to abandon your new domicile so quickly. The scenario Hank proposed would never fly. However, I couldn't say how long he would have to stay in Florida to make a convincing argument that he had established a new domicile there. All of the facts and circumstances would be taken into account to make that determination.
As for the inclusion of income from other sources to determine the rate that applies to in-state income on a part-year resident or nonresident income tax return: The "as-if" method used by most states that have graduated income tax rates has been upheld by the courts in several states as well as by federal courts, and never addressed by the U.S. Supreme Court. The earliest example I know of is the Vermont Supreme Court's decision in _Wheeler v. Vermont_, 127 Vt. 361, 249 A2d
887 (1969), app. dism., 396 U.S. 4, 90 S. Ct. 240. The method was challenged in California in _Staples v. FTB_, Court of Appeal, Third Appellate District, Dkt. No. C038428, 4/10/2002 (unpublished), cert. den. U.S. S. Ct., Dkt. No. 02-422, 11/18/2002. The U.S. Supreme Court declined to hear either of these cases. The Vermont case involved a nonresident who objected to having his New Hampshire source income included in the calculation of his Vermont tax rate. The California case involved a part-year resident.
Similar constitutional attacks were rejected in Maine and Kansas. The Kansas case was litigated in federal court; the federal government challenged the inclusion of a nonresident service member?s military compensation in computing the rate of tax on the member?s Kansas source income, under the Soldiers? and Sailors? Civil Relief Act. The
10th Circuit Court of Appeal held that the federal statute was not violated because the military compensation was not taxed. _United States v. Kansas_, 810 F.2d 935 (10th Cir. 1987)
In 1987 the State of New York adopted a method of calculating nonresident tax liability similar to California's, generally effective for years beginning in 1988, to the consternation of residents of New Jersey and Connecticut. As a result, federal legislation was introduced that would have temporarily suspended the New York law as well as any similar legislation subsequently enacted by any other state (S 800, introduced 4/13/89). Like most attempts to pass federal laws limiting states' rights to devise their own taxing schemes, this one went nowhere. (Watch out for BATSA, though .)
Notice that although it is often referred to as the ?California method,? this method of calculating the tax liability of nonresidents and part-year residents was in use in a number of states long before its adoption by California in 1982. The years at issue in _Wheeler v. Vermont_, supra, were 1966 and 1967.
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