SESSION 6
How Should You Time Your Domicile Change?

If a retiree is considering a change in domicile, he should time the actual date of the domicile change in a manner most advantageous to himself. This is especially important where the retiree is selling a business since he may be able to avoid the New York capital gains tax if the sale occurs after the domicile change. Also, where trusts are established in the same year as the domicile change, there may be tax advantages in delaying the trust until after the change of domicile has occurred. The retiree's accountants should be consulted ahead of time concerning accrual accounting which may be required in the year of change.

If the retiree sells his business prior to the change of domicile, any resulting capital gain will be subject to New York income tax. Often, such a sale will be on an installment basis with the expectation that state and federal taxes are prorated over the period during which the sale price is received. He may be shocked to learn that he must accrue and pay New York tax upon the entire gain with his last resident return unless he posts a bond. On the other hand, if the New York business is sold after the retiree's change of status, any New York tax can be reported on an installment basis and no bond need be posted. More importantly, since a nonresident is not taxed by New York on capital gains from intangibles, by deferring the sale of a New York business in corporate form that is subject to corporate taxation until the change in status occurs, the retiree will escape the New York capital gain tax entirely.⁽¹⁾

The tax savings can be substantial. For example, assume that a New York resident retiree is in the top income tax bracket and has a capital gain of $100,000. The federal tax will be 15% or $15,000. The New York income tax will be 7% or $7,000 because New York does not treat capital gains any differently than its tax on ordinary income. The $7,000 may be deductible on the Federal return unless it is reduced or eliminated because of the Federal minimum alternative tax. Where the capital gain results from the sale of a family business and the gain is in the millions of dollars, a change of domicile before the transaction takes place may result in a very substantial savings if the retiree is not a statutory resident in the year of sale. Check with your professional advisor well in advance of the sale if you have any thoughts about becoming a Floridian.

As we discussed in the last session, a person is a resident and fully subject to New York taxes even if domiciled in Florida if he maintains a permanent place of abode in New York and spends a total of more than 183 days of the taxable year inside the state. Therefore, a retiree who changes his status after July 2 of any year and continues to maintain a residence in New York, will not have a change of status for income tax purposes until the following year if he was actually present in New York from January lst to July 2nd.

The New York Tax Law requires an individual whose status changes from New York resident to nonresident to accrue items of income, gain, loss or deduction (including any unrealized income from an installment sale) which under an accrual method of accounting would be reportable at the time the taxpayer changed residence on the nonresident and part-year resident return for the year that the change of residence occurred. These accruals are required even though the individual normally reports such items on another accounting basis. The special accruals also apply to the computation of the minimum income tax and the separate tax on lump-sum distributions.⁽²⁾

An exception is where the taxpayer files a bond or provides other acceptable security to assure the payment of taxes when income is realized and agrees to report the accruable amounts on future New York State nonresident and part-year resident income tax returns as if a change of resident status had not occurred.⁽³⁾

Timing was especially critical to Edward who sold his interest in a New York corporation at a considerable profit in September 1970. Edward spent more than 183 days in New York State in 1970. Nevertheless, no New York income tax would have been taxable if he had been able to demonstrate that in September 1970 he was not domiciled in New York and that during 1970 he did not have a permanent place of abode in New York. In December 1969, Edward purchased a residential lot in Florida and in January 1970 placed his New York home on the market for sale. He was not able to sell his home until July 1971. Edward had a summer home in Vermont where he lived during part of 1970. However, during this time the furniture remained in his New York home, he maintained the house, and the telephone and utility services were continued. The court held that Edward did not change his domicile in 1970, and that even if he had he was subject to tax because he maintained a permanent place of abode in New York and spent more than 183 days in New York.⁽⁴⁾ If Edward had held off the sale of his business until the following year or had sold his house earlier, he would have avoided a substantial New York tax.

The timing of a change of domicile may also be important where the retiree is creating one or more irrevocable trusts. The tax consequences may differ depending on whether the trust is created prior to, or after, the change of domicile.

If the retiree, while still domiciled in New York State, creates a trust, it is a New York resident trust for income tax purposes.⁽⁵⁾ This is so whether it is irrevocable or revocable. It continues to have such status after the retiree changes his domicile to Florida up until the time of his death. If the retiree dies a domiciliary of Florida, the irrevocable trust so created continues to be treated as a New York resident trust. The revocable trust becomes irrevocable upon death and thereafter is a New York non-resident trust. Conversely, if either a revocable or non-revocable trust is created after the retiree's change of domicile, it thereafter is a New York non-resident trust. The New York taxable income of a resident trust is its Federal taxable income subject to certain limited modifications.⁽⁶⁾ Thus, although the retiree later moves to Florida, undistributed trust income of an irrevocable trust, including any capital gains of the trust, will continue to be subject to New York tax. Such would not be the case if the irrevocable trust had been established after the change of domicile. Where the trust is revocable, there should be no adverse tax consequences even if the trust is created prior to the retiree's change of domicile, since New York treats all income of a revocable trust as being the income of the grantor retiree.⁽⁷⁾ Once the change of domicile becomes effective, only certain New York related income (e.g., rent from New York real property) of the revocable trust will continue to be subject to New York income taxes, but this would be so even where the revocable trust is created after the change of domicile or the assets are held directly by the retiree.

There is an exception to the general rule that New York taxable income of a resident trust is its federal taxable income subject to certain limited modifications. The determination of whether a trust is a resident trust is not dependent on the location of the trustee or the corpus of the trust or the source of income. However, these factors when taken into account might exempt the trust from New York State personal income tax even though it continues to be a resident trust. To qualify, all of the following conditions must be met:

a. All the trustees must be domiciled in a state other than New York State.

b. The corpus of the trust must not include any real or tangible property located in New York State; and

c. All the income and gains of the trust must be derived or connected from sources outside of New York State, determined as if the trust were a nonresident. This last requirement does not mean that the trust cannot have a portfolio of stocks and bonds held by a New York broker. This is so since the situs of the intangible assets will be deemed to be at the domicile of the trustee. Therefore, the situs of the corpus of the trust will be deemed to be outside of New York State. But be careful. None of the securities can be employed in a business carried on in New York.⁽⁸⁾ When a snowbird has created an irrevocable trust prior to his or her change of domicile consideration should be given to cleansing the trust so that it meets all three requirements. For example, any New York trustee might resign and be replaced by a non-New York trustee. Any real or tangible property held by the trust might be sold and replaced with intangible assets.

The proper timing of a domicile change may be important in excluding the capital gain on a principal residence. Remember that once a change of domicile occurs that the retiree's principal residence is most likely his Florida residence. In 1997, Congress replaced the old rollover provisions and the one-time exclusion provisions with a new exclusion. Under the new tax provisions a taxpayer is generally able to exclude up to $250,000 ($500,000 if married and filing jointly) of gain on the sale of a principal residence. To be eligible, the residence is required to have been owned and occupied as the taxpayer's principal residence for at least two of the five years prior to the sale. The exclusion is allowed each time a principal residence meets the eligibility requirements, but generally not more than once every two years.

The Act contains a "Relief Provision" for taxpayers who sell their principal residence but fail to meet either (a) the 2 out of 5 year ownership and use test or (b) the once every 2 year rule. Failure to meet the above tests will not totally preclude taxpayers from the exclusion if the sale is due to a change in place of employment, health considerations, or unforeseen circumstances.

It had been the position of the Department that an interest in a New York partnership represented an interest in real or tangible personal property in this State, or constituted an intangible employed in a business trade, profession or occupation carried on in this state. Accordingly, any gain or loss realized upon its sale was held to be gain or loss derived from or connected with New York sources pursuant to sections 631(b)(1) and (2) of the New York State Tax Law.

Upon reviewing the matter, the Department decided that a gain or loss (whether treated as capital or ordinary for federal income tax purposes) from the sale of an interest in a New York partnership, except in limited situations, did not constitute gain or loss derived from or connected with New York sources and is not includible in the New York source income (the numerator of the tax allocation fraction) of a nonresident individual, estate or trust.⁽⁹⁾

A very instructive opinion was rendered on the “timing issue” on July 13th, 2006 In the Matter of Reiner, DTA No. 820266, 2006 WL 2077331 (N.Y. Div. Tax. App.). Fortuantely, Reiner won the case even though he changed his domicile from New York to Florida shortly after the business was sold. He erroneously relied on certain regulations and other pronouncements that appeared to make the critical date the end of the partnership year rather than the earlier date of the sale. Reiner successfully argued that New York State, under the unusual circumstances, was estopped from imposing the tax. It is noteworthy that the opinion also recognizes that it is perfectly alright to plan the domicile change ahead of time when a sale of business is contemplated, stating:

Given the clarity of petitioner’s focus in the sale of SQP on his “bottom line” result, and the direct impact of the tax at issue thereon, it is abundantly clear that, but for such reliance on the regulation, petitioners could and would have made their move out of New York at a different time, i.e., prior to 1997, so as to achieve the result they sought in mitigation of the tax impact of the sale of SQP. This is a simple matter of legitimate tax planning that petitioners were unquestionably permitted to pursue, but are being effectively deprived of after the fact under the imposition of the tax deficiency herein asserted against them.

CAUTION: Before making a domicile change, the retiree should request his attorney and accountant to review the most recent laws, regulations and cases and seek his advice as to the proper planning for such change.

1. N.Y. Tax Law Sec. 631(b)2 provides that income from intangible personal property, including gain from the disposition of intangible personal property, constitutes income derived from New York sources only to the extent such income is from property employed in a business, trade, profession, or occupation carried on in this state. It would appear that the gain from the sale of capital stock of a corporation would be excluded since the stock is not "employed" in the business. Some consideration might be given to incorporating a business to avoid the tax where the gain is substantial if there are no other adverse consequences.

2. 637(b), and 1307(b).

3. 637(b), and 1307(b).

4. Smith v. State Tax Commission, 68 A.D.2d 993, 414 N.Y.S.2d 803 (3rd Dept. 1979).

5. N.Y. Tax Law Sec. 605.

6. N.Y. Tax Law Sec. 618.

7. N.Y. Tax Law Sec. 618 defines New York taxable income substantially similar to Federal taxable income and, under Subpart E of the Internal Revenue Code, the grantor includes the income of the trust in his personal income tax return.

8. See, Advisory Opinion TSB-A-96(4)(I).

9. Memorandum TSB-M-92(2).