New York City mayoral front-runner Bill de Blasio invoked “tale of two cities” rhetoric — including a tax-the-rich plan — to win the Democratic primary. That almost assures him of winning the election in the heavily Democratic city.
Some high-income NYC residents are considering an exodus. Everything is already very expensive, including rents, condos, private schools, services and especially taxes. But before you rush to rebalance your work and lifestyle to tweak your days spent in NYC, understand there are many myths about quick fixes and most fail in practice. Learn the NYC residency rules and respect the might of tax authorities in interpreting the rules in their own favor.
NYC is the highest taxed city in America already!
As the biggest U.S. city with quite a security-budget requirement, you can imagine it costs plenty of money to run, even with Mayor Bloomberg at the controls. A recent report indicated that 50% of the residents are under the poverty line. But NYC is no Detroit and there are Wall Street multi-millionaires living in towers all over Manhattan and Brooklyn. In 1975 NYC also faced bankruptcy, before Wall Street’s ascension to fame and fortune.
For NYC residents making over $500,000 per year, the top marginal income tax rate is 3.876%. Bill de Blasio’s tax plan is to raise that rate to 4.41%. A married couple making around $500,000 may not have any savings left at year-end after paying for expensive private schools for their children and other high-priced services.
If you own a business in NYC, there’s an additional “unincorporated business tax” (UBT) of 4% on pass-through entities and sole proprietorships. Corporations are assessed a “general corporation tax” of 8.85%. New York state’s “flat tax rate” on corporations is 7.1%. (A trading business is exempt from UBT, as that is portfolio income.)
Very few U.S. cities assess individual income taxes and/or business income taxes. (Pennsylvania and Ohio have local school taxes on earned income but the rates are fairly low, except in Philadelphia.) Most cities and towns collect tax revenue from property taxes, real estate taxes and sales and use tax.
Gov. Cuomo already passed a “tale of two cities” plan in 2011
New York’s Gov. Andrew Cuomo said he was “not thrilled” with de Blasio’s tax plan. I’m skeptical because in 2011, Cuomo raised rates on the wealthiest residents to 8.82% — temporarily through 2014 — while cutting taxes on married couples earning less than $300,000 a year. Technically, that’s a tale of two cities tax plan. First, candidate Cuomo campaigned on allowing the temporary “millionaires tax” to expire as scheduled, but he later flip flopped as governor to extend the millionaires tax.
NYS/C’s combined top tax rate after these tax hikes is 13.23%; factoring in the 4% UBT tax on business puts the rate at 17.23%. An investment manager relocating to Florida saves all these NYS/C taxes. Many investment advisers and professionals moved their residences and businesses to Connecticut where the top tax rate is 6.5%, saving 10% of their highest-marginal income.
President Obama passed a similar plan
In the hotly debated fiscal cliff deal forged at the last minute of 2012, President Obama passed a “tale of two cities” tax-the-rich plan. President Obama didn’t sacrifice his long-held position to stop Bush-era tax cuts for the upper 2% of taxpayers making over $300,000 married and $250,000 single. The top tax rate returned to the Clinton-era 39.6%, plus the agreement phased-out itemized deductions and personal exemptions, effectively raising the rates even higher. Bush-era tax cuts continued for 98% of American taxpayers. President Obama passed other middle-class and small-business tax cuts, too.
“Progressivity” is widening with these tax-the-rich plans
Even without Occupy Wall Street succeeding in its mission, it’s pretty evident now that there’s a trend among Democrats for invoking “tale of two cities” rhetoric, including tax-the-rich plans. It’s good politics (and they believe more fair) to advocate tax hikes for the rich, tax cuts for the middle class and transfer payments and subsidies like ObamaCare for the poor. This is not a political statement but a new reality on the ground.
What’s an upper-income family in a high tax area to do? Embrace income tax hikes coming to your state and/or city soon, pay them with a smile and enjoy your city’s great lifestyle, diversity and culture. Or, consider rebalancing your affairs to successfully become a non-resident of your high-tax state and city.
How easy is it to change your tax residence?
Don’t fool yourself; it isn’t easy. Unless you pack your bags and move your possessions out of NYC, give up a “permanent place of abode” and stop coming on most days, you will probably remain “domiciled.”
Many other high-tax states have similar rules and concepts on residency, so read them carefully online. The days of fooling states are over — they’re much more sophisticated now and the burden of proof is on you.
Exiting a state or city is easier than exiting the U.S.
Simply “move out” of NYS/C and you are a non-resident as of the date of your move. You may have some leftover NYS source income such as from the sale of real property. Non-residents of NYS owe state taxes on NYS source trade or business income, not portfolio income.
It’s far harder to escape the IRS, as it has you bound as a tax indentured servant for 10 years. You can surrender your green card at your foreign consulate and move out of the U.S. entirely. But the IRS “exit tax” or “expatriation tax” applies for 10 years after you leave on long-term residents and citizens.
State rules to avoid double taxation
Just because you can show you are domiciled in another state, doesn’t mean NYS/C can’t argue that you are really a NYS/C “domiciled resident” or qualify as a “statutory resident.”
Most states have a system to get tax relief for double state taxation. For example, NYS residents can deduct state income taxes paid in another state and they usually get full relief since NYS tax rates are higher than most states. Conversely, a Florida resident has zero income taxes and they won’t get any relief for taxes paid to NYS.
There is no double taxation relief for NYC taxes paid.
NYS/C “domicile residency”
NYS Tax Department’s definition states “Your domicile is: the place you intend to have as your permanent home; where your permanent home is located; the place you intend to return to after being away (as on vacation, business assignments, educational leave, or military assignment). You can only have one domicile. Your New York domicile does not change until you can demonstrate that you have abandoned your New York domicile and established a new domicile outside New York State…”
It’s where your roots are in the ground on all fronts, including economic, financial, family and community.
There are plenty of good resources on the Internet on NYS/C residency, like this one from the NYS Society of CPAs.
NYS/C “statutory residency”
The NYS Tax Department also defines a “statutory resident” as follows: “Your domicile is not New York State but you maintain a permanent place of abode in New York State for more than 11 months of the year and spend 184 days or more in New York State during the tax year.”
If you work in NYC, you will probably spend 184 or more days in the city. Renting an apartment for two years will subject you to NYC resident taxes, whereas short-term stays in a hotel or furnished apartment for only a few months will not. Non-resident commuters get off scott free. That nice pied-a-terre you have in mind just won’t fit the family budget after you factor in another 4% income tax and perhaps more if business taxes apply.
There are countless cases you can read online about taxpayers trying every angle to avoid domicile or statutory resident designation. For example, you can’t rent an apartment in your child’s name, since you will have “key access” and have to “maintain” it, which are the rules that count.
The 184 day rule feels more like 100 days
Don’t just figure 184 days is half a year; it’s not easy staying under 184 days, as you need to count partial days.
For example, visiting your NYC apartment for just one night counts as two days. Try to maximize your day count by spending longer blocks of time. Be prepared to be stingy with your days in NYC, and carefully plan what you devote them to in terms of seeing people, clients and coming to events. It can be a pain and hindrance.
Are you really going to save much?
Don’t forget to factor in the cost of maintaining your new domicile and travel costs, too. Don’t make this move on principle alone — run pro-forma tax returns to see the actual concrete tax savings vs. other costs incurred. You should factor in the risk of NYS/C audit and disagreement, including back taxes, penalties and interest. States rarely abate penalties.
The burden of proof of residency is on the taxpayer
Don’t even dream of fudging the numbers. You have to prove your residency and you need to cobble together an assortment of different methods to do it, including: Easy Pass records for driving over toll roads, bridges and tunnels; credit card and ATM transactions; cell phone tower records if you can get them; and internet access through IP tracking to your server if you can get this complex information; landline phone records. Also, some smartphone apps track your daily GPS whereabouts, but they often crash or have cessation of service.
One famous hedge fund manager fought with NYC over just one day, as it would tip the balance to cause residency and trigger a NYC tax bill of tens of millions of dollars.
Consider an example of a married couple interested in exiting from the NYC tax regime. The wife has a long-term job making around $250,000 per year on a W-2. The husband recently converted from being an employee to an independent contractor reporting 1099-Misc. non-employee compensation of $300,000 on a Schedule C. They trigger the top NYC marginal tax rate of close to 4% and the husband also owes NYC UBT tax of an additional 4% on his net Schedule C income.
For several years, the couple traveled to their country home outside of NYC on weekends. They raised their family in NYC in a large condo which they purchased decades ago. They have been domiciled residents of NYS/C for decades and they have averaged well over 200 days per year in the city.
How can they rebalance their lives to exit the NYC tax structure? This couple may be tempted to tweak their work and lifestyle a bit, spending more nights in their country home vs. their NYC apartment. But, that’s highly unlikely to convince NYC they “abandoned” their NYS/C domicile, even if they vote in the country and move car registrations and more technicalities as well.
To safely accomplish abandoning domicile in NYS/C, this couple should sell their condo and not have any place of abode in NYC for a few years, while they establish a replacement domicile outside of NYC. Downsizing to a small NYC apartment is not enough, especially since these are still very high priced and the couple is maintaining significant economic and personal connections in NYC. (This couple can benefit from the $500,000 exclusion of income on the sale of their primary residence.)
After moving to Florida for a few years, this couple can get a place of abode in NYC again. At that juncture, they can probably safely claim a domicile change to Florida. Then, only “statutory residence” should be a consideration. It now becomes a question of counting days and they need to stay under 184 days in NYC per year. Each year is assessed separately.
For statutory residency calculations, a husband and wife should count their days in NYS/C separately, as they can file a joint federal return and separate NYS/C returns.
Will NYS/C let them go? No one likes to lose a good customer, especially high-tax states. NYS and NYC have huge tax departments and they spend the majority of their resources on residency audits. Many residents try to game the tax system and once audited, many are busted with back taxes, interest and penalties. They try all sorts of failed angles. You shouldn’t bother with those.
Consult a state and city tax expert
Don’t rely on a tax advisor in the low-tax state that wants your business; make sure you get advice from a CPA or tax attorney with excellent experience and practice in the state you seek to exit from.
State residency rules and nexus are complex, nuanced and often vague. States increasingly are looking at economic nexus and intangibles, rather than just focusing on technical facts like where you register to vote, register your cars and get your driver’s license. States look at where your family conducts its affairs like attending school, seeing friends, community activities and much more.
States are hungry for tax revenues and they don’t like losing their tax base, especially when in fact they haven’t lost them, but rather the taxpayer in question feigns non-residence.
The next mayor of NYC may raise taxes in a material fashion on the upper income. Many of these taxpayers don’t appreciate that and they are in a position where they can move out of the city. They can still enjoy the NYC lifestyle and do some business using temporary hotel stays, which is not a place of abode. In a year or two, they can get a pied-a-terre in NYC, and only pay sales and property taxes, not income and business taxes.
Maybe lowering NYC taxes would invite more rich residents to call the city their home and it could then benefit from huge growth in business and overall tax revenues.