SESSION 7
What Can You Expect To Happen If You Become The Target Of A New York State Domicile Audit?

Retirees with substantial federal taxable income should anticipate being the target of a New York tax audit. The retiree should alert his accountant or lawyer immediately when the first audit inquiry is received. This session describes the audit procedure including the audit questionnaire and the type of records that must be produced. It also explains what to expect as the audit progresses and the available relief if a notice of assessment is issued.

In the last several years, New York State has been targeting for income tax audit Florida retirees with substantial Federal taxable income who continue to reside in New York State during part of the year. The audits have resulted in substantial additional income tax revenue to New York State, and will continue.⁽¹⁾

On July 25, 1997, the New York Department of Taxation and Finance issued a revised 101-page manual to its auditors in field offices throughout the state instructing them on how to track down snowbirds and assess additional New York taxes.⁽²⁾ After reviewing the manual, one might ask: Isn't a person entitled to some privacy? Is New York going too far to collect revenues and isn't there likely to be a backlash where former New Yorkers will simply spend their summers elsewhere? Let's look at some of the techniques.

The manual suggests:

* that the auditor pay particular attention to New York addresses on the tax returns and notes that the envelope attached to the return may indicate a New York address or the envelope may be postmarked from a New York State location.

* the Wage and Tax Statements may reveal that the information return was sent to the taxpayer's New York address.

* the supporting schedules in the return can provide insight into a taxpayer's business involvement in New York especially where the taxpayer's surname is part of the employer's name.

* the auditor uses various computer files available from the Internal Revenue Service, New York State agencies and other states. For example, the IRMF tape made available by the IRS includes all information returns (1099's, K-1's, W-2's) sent to a payee's New York address. Some taxpayers have a computer profile which includes all filing history dating to 1982 as well as information concerning tax exempt bond interest and withholding taxes.

* the auditor check out the various city directories subscribed to by the Department which provide information as to the length of time a taxpayer has resided at a particular location.

The manual brags that the Department's use of the various computer files as well as its internal files has made it a model for the successful use of computer data throughout the nation.

The non-resident income tax return requires the taxpayer to set forth both the federal income subject to federal income taxes and the New York income subject to New York income taxes. Where there is a substantial difference between the two amounts, the auditor knows that if the Department can assess a tax based on residency rather than non-residency that a substantial amount of additional tax can be collected. It is these returns that are given most attention.

The chance of proving that the taxpayer can be assessed substantial additional taxes is further enhanced if the taxpayer has indicated on the return that a place of abode is maintained in New York State or if the internal investigation reveals a New York presence of the taxpayer.

The auditor will make the initial contact with the taxpayer by a letter which indicates that the New York Nonresident Personal Income Tax Return is being reviewed and that the nonresident status will be addressed. A questionnaire will probably be enclosed asking:

* When was your last New York State resident personal income tax return filed?

* Provide detailed information relative to your intentions when you changed your status from a resident to a nonresident.

* Are you associated with any business activity conducted in New York?

* During any of the tax years under audit did you own, rent, lease or otherwise maintain living quarters in New York and, if so, is it subject to rent control or rent stabilization?

* If you do not maintain living quarters in New York State, where do you regularly stay while in New York State?

* For the years under audit, state how many days or part-days you were physically present in New York State.

The initial audit questionnaire may not be taken too seriously by the retiree because he is comforted by the fact that no challenge has ever been made in the past to his change of domicile. He may be further comforted by the fact that many of his Florida acquaintances continue to maintain their former New York residences throughout the year, have similar life-styles, and their change of domicile has never been questioned. The retiree should be aware that New York State is now challenging changes of domicile that occurred several years ago. The retirees may be 70, 80 or even 90 years of age. It is no defense to argue that there are many other retirees who have similar situations who are not being audited. Their turn may come.

The first thing the individual should do when the questionnaire is received is contact his professional advisor. Answering the initial questionnaire is very likely to be the beginning, not the end of the audit process. It is important at this stage that all facts supporting a domicile change be marshalled in a logical fashion and be presented in the most effective manner.

Regardless of how the first questionnaire is answered, a retiree with homes in both Florida and New York should expect a second questionnaire to follow once a response is given to the first questionnaire asking more detailed questions such as:

* Have you disposed of a dwelling place located in New York and, if so, when and how?

* List all prior homes located in New York State.

* State whether the place located in New York State where you stay is furnished with your own furniture.

* Are any of your belongings or furniture still in New York and, if so, what are they? If not, give the dates when you removed your furniture and belongings to Florida.

* Are you actively or passively associated with any business activity in New York?

* Since the year you claimed nonresidence in New York have you executed any bond, lease, or any other document in which your residence is stated?

* Since the year when you first claimed to be a resident of Florida have you executed a Last Will and Testament?

* Where is your auto, boat or airplane registered and where was your driver's license issued?

The manual suggests that the auditor using the above pre-audit analysis and the questionnaire as a starting point, explore and develop through personal conversations the various elements needed to determine involvement in New York. Without professional guidance, the retiree is apt to talk too much. The manual anticipates this and cautions: "The auditor must learn to develop his/her listening skills and nudge the conversation in the direction necessary to provide the information needed to make a decision." NUDGE the taxpayer! Should nudging be the role of a state auditor?

The manual suggests that the auditor visit the taxpayer's home in New York and have a "walk through". The manual states that the personal observation should include "checking the names on the mailbox, checking the license number of any vehicle on the premises, and interviewing the doorman, building superintendent and mailman. If a "walk through" is denied, the auditor is to request pictures or a videotape of the premises.

One auditor called a retiree in Florida and requested a personal interview. The retiree responded: "I won't be able to see you until I return home in the Spring." Wrong response! If the retiree had changed his permanent home to Florida he should have responded: "I won't be able to see you until I visit New York in the Spring."

Most professional advisors will discourage any personal contact between the retiree and the auditor and will act as the conduit for answering all questions. No doubt the auditor will be less effective in NUDGING the attorney or the accountant and the facts are more likely to be disclosed in a more straight forward manner.

At some point the auditor will request all cancelled checks, bank statements, telephone bills, credit card statements and country club statements for the years under audit. Some auditors will examine these records for several days at the office of the attorney or accountant with the assistance of a lap-top computer with special software that analyzes the various entries and produces a twelve month calendar coded to show likely days in and out of New York State.

The manual points out the information that can be learned from cancelled checks and bank statements both with regard to domicile and the number of days present in New York. The manual does state that the physical location of the banking institution is not significant, although it points out that some importance should be placed on the address to which bank statements, financial statements and other information is sent, as well as the location of safe deposit boxes used for family records and valuables. The manual points out that access to an ATM machine should be reviewed because the information will usually disclose an exact location where the individual was on a particular day. It also points out that the auditor should scrutinize such personal expenses such as groceries, hair dressers, club dues and entertainment noting the date that the checks were written. It suggests that the auditor analyze credit card receipts to disclose attendance at sporting events, theatrical performances or dinner in New York which may be significant in establishing a day's presence in New York.

The manual points out that employing a financial institution located in New York which provides activities such as handling insurance policies, stock transactions, managing a portfolio and everyday expenditures is not in itself a controlling factor, especially if the taxpayer plays a passive role in these activities. Does this mean that having a New York stock broker is not to be taken into account as a factor? It is somewhat troubling that the manual refers to a "controlling" factor.

The manual suggests that the auditor review insurance policies to give some insight as to the assets present at various locations, such as works of art, collection of stamps, coins and rare books that are often covered by insurance riders, that could be helpful in determining a taxpayer's life-style. It also suggests that the auditor check utility bills in determining usage patterns at more than one location, including cable companies which often have disconnect the reconnect notices, to substantiate when an individual may be present at a specific location.

Based on the facts gathered by the auditor, the auditor has to determine whether or not the retiree effectively changed his domicile and whether or not the retiree was present in New York for more than 183 days in each year under audit.

Prior to the issuance of the manual, auditors would emphasize various domicile factors during the audit process and there was not a uniform approach from field office to field office or even within a field office. The manual, in an attempt to have a more uniform approach, has designated five primary factors that all auditors are to consider:

* The individual's use and maintenance of a New York residence compared to the nature and use patterns of a non-New York residence.

The manual first asks: "What does an individual consider to be his/her home?" It then points out that it can be the actual dwelling or the area and can be either depending upon the circumstances. It gives the example of a couple who resides in a particular community while raising their children and sells the residence to purchase or rent a smaller residence in the same community after their children are grown. The manual suggests to the auditor that the new residence, regardless of the length of time spent there, takes on the full range of sentiment the couple has for the community in which they reside.

Of course, where an individual only has one home, decisions concerning domicile are more straightforward. Thus, when a New Yorker sells his New York home and purchases or rents a Florida home there is generally not a serious domicile issue. But what about the New Yorker who maintains both a New York and Florida home but has his New York home "up for sale?" The auditor is to look at the listing price of the property to determine whether it is significantly above market value and whether the New Yorker is actively trying to sell the property. It will help during the audit process if it can be shown that, even though the property has not yet been sold, the family heirlooms, treasured possessions, etc. have been moved to the new location.

This seminar is directed at the retiree who maintains both a New York home and a Florida home.

The manual reminds the auditor that in order to change domicile, both the intent to abandon the former domicile and to take up the new and an actual residence at the new location must be present, and that the test with respect to a purported new domicile is whether the home in Florida has the range of sentiment, feeling and permanent association with it to be considered the home of the retiree. The manual reminds the auditor of the Newcomb case discussed in Chapter 1. It states that the retiree asserting the change of domicile must show the necessary intention exists by clear and convincing evidence.

The auditor is to compare the size of the residences at both locations as well as the value of the residence.

During the audit process, the retiree may advise the auditor that he or she prefers to use a former principal residence as a seasonal home or hotel substitute after moving from New York and that they have no economic need to sell the New York home. The manual instructs the auditor to give this explanation some weight, especially where the retiree has been successful in his or her career and the need to dispose of the New York residence has been diminished.

Some retirees think that by renting a New York apartment or home they have obviated the domicile issue. Not so. The manual indicates that it makes little difference when analyzing the "Home" factor whether the individual owns or rents a particular dwelling.

The auditor is also asked to analyze whether the retiree may employ domestic help, grounds keepers, chauffeurs, etc. at one location but not the other.

Some retirees who have moved to Florida would like to sell their New York home but are hesitant to do so because of the capital gains tax that is payable because the New York home is not their principal residence. Upon the retiree's death, the New York residence will receive a step up in tax basis and the capital gain tax can be avoided. The manual suggests that this may be a reason for retaining the New York residence.

* * *

There are four other primary factors that the auditor is required to examine: Active Business Involvement, Time, Items "Near and Dear" and "Family Connections.

* * *

* Active Business Involvement.

This seminar is directed at the retiree. However, some retirees continue to maintain some active business involvement, especially where there is a family owned business that is now run by a son or daughter.

The manual quotes at some length from the Kartiganer case discussed in Chapter 1. The message is that the "retiree" may be in some trouble if he plays an active role in the day to day operations and continues to maintain a degree of control over the business interests. In one case, the individual's own words were used to document his New York business ties. He was quoted as stating that he was "deeply, deeply involved" in the operation of the business and felt that his involvement was "vital to the health of the company."⁽³⁾ It is not necessary for the retiree to give up all of his New York business interests. The manual refers to the Burke case (discussed in Chapter 1) and points out that Mr. Burke configured his business to be managed by others and made his home in Florida where people of like circumstances, aims and means were situated.

The manual points out that as persons become older and accumulate wealth, they may choose to devote less time to the business and bring in younger individuals who will eventually succeed them, ever reducing their status and compensation. The auditor is told that this alone does not demonstrate a change of domicile and is only one element of the "active business involvement" factor.

* Time

Some retirees think that so long as they have not spent more than 183 days in New York there is no point in increasing the number of days spent in Florida. They are wrong. The manual points out that in weighing the "time" factor, if the taxpayer merely changes from spending six months per year in Florida to spending seven months there, this minimal alteration, by itself, does not constitute strong evidence of a change of domicile.

The retiree who "cuts it close" may find it quite difficult. On the other hand, the auditor should recognize that many retirees who have clearly changed their domicile to Florida spend more than five months "up north."

* Items "Near and "Dear".

It will be helpful in the audit process if the retiree has moved to Florida such items as family heirlooms, works of art, collection of books, stamps and coins, family photo albums and even pets. The manual indicates that even though the transfer of some of these possessions to Florida could be viewed by some as a mechanical or self-serving act, consideration must be given for those items located outside New York.

In one recent domicile case that I had, the administrative law judge asked my client where she kept her "good china." Fortunately, she had moved it to her Florida home.

The manual does acknowledge that some items that are "near and dear" might be kept in the New York residence because they are more suitable there or for reasons of preservation or safekeeping.

* Family Connections

The last primary factor "Family Connections" when initially suggested in an early manual raised an outcry by many retirees and their advisors. They pointed out the intrusive nature of this inquiry. As a result, the new manual is much more cautious and suggests to the auditor that the factor be limited to the retiree's immediate family, and points out that for most purposes this will consist of the individual, the spouse and any minor children. Most retirees will not have any minor children. If the auditor starts inquiring about time spent with grandchildren, it should be pointed out to him in a very polite manner that it is none of his business and cite his own manual at page 25.

* * *

Despite the Department's own Manual to the contrary, in a recent case, the Administrative Law Judge placed great emphasis on the taxpayers' great pleasure when they were with their grandchildren who resided in New York. At the hearing, the taxpayer's daughter testified that her parents had few pleasures and that the grandchildren were "their sole source of pleasure". In his decision the ALJ pointed out that the taxpayers retained their Brooklyn home after they purported to change their domicile to Florida and spent approximately the same amount of time in Florida and New York, both before and after their change of domicile. The ALJ emphasized the fact that the grandchildren were their sole source of pleasure. The Manual was not referred to in the decision. Click on Matter of Slotkis, 2002 WL 394249 (DTA No. 817952, March 7, 2002).

The manual also lists "Other" factors but points out that these are subordinate to the primary factors and in virtually all cases it is usually not necessary to review them as part of the domicile audit. The auditor is admonished not to take these into account unless a conclusion cannot be reached solely upon the primary factors.

The problem is that most retirees for whom this seminar has been prepared will have two homes and are likely to spend close to the six months in New York. Therefore, it is likely that the auditor will review these "Other" factors. Therefore, it is of utmost importance to make these "Other" factors work to the retiree's benefit even though it may cause some slight inconvenience. These other factors are:

* The address at which bank statements, bills, financial data and correspondence concerning other family business is primarily received.

* The physical location of the safe deposit boxes used for family records and valuables.

* Location of auto, boat and airplane registrations as well as the individual's personal driver's or operator's license.

* Where the taxpayer is registered to vote and whether he exercises that privilege. It is important to vote not only in the general elections, but also off-season elections, including school board and budget elections. Do so even if an absentee ballot is required.

* For those retirees who live in New York City, don't possess a New York City parking tax exemption.

* It would be preferable to de-list the New York telephone number and limit its service features.

* The retiree should make sure that he specifically recites in his Last Will and Testament and other legal documents that his place of domicile is Florida. Normally, reference will simply be made to "residence", but since the manual lists the statement of "domicile" as a factor, the instruments should refer to the place of domicile.

* The active involvement in an organization, particularly where physical presence is involved, is to be considered as one of the "Other" factors. This includes the holding of office, regular attendance at meetings, and the volunteering of services which demonstrates an act of presence at the particular location.

* * *

There are certain "non-factors" that the auditor is not to question. If he attempts to do so, he should be referred to page 32 of his own manual. These non-factors include: the place of interment; the location where the taxpayer's Will is probated; passive interest in partnerships or small corporations; the mere location of bank accounts; contributions made to political candidates or causes; the location where the taxpayer's individual income tax returns are prepare and filed; where charitable contributions are made; religious organization membership.

The manual states that weekly or regular attendance at services at a church or synagogue is not to be considered active participation in New York.

Despite the inclusion of some items as non-factors, and the differing weight the manual affords to primary factors and "other" factors, the Court, the Tax Tribunal and Administrative Law Judge, and even some auditors are likely to apply their own standards to the facts of the particular matter before them.

What conclusion can be drawn from the above analysis? Will auditors "loosen up" or "tighten up" on domicile audits? The introduction to the guidelines gives a ray of hope. It states:

* In making a determination of domicile, the decisive question is not whether the taxpayer continues to maintain some links to New York, but whether the remaining ties to New York demonstrate that New York is, in fact, the taxpayer's home.

* Our actions, as representative of the state, should encourage taxpayers to invest in New York by keeping bank accounts open in the state and to seek expert advice from varied professionals located in New York.

* It is also required that a common sense, practical approach be applied to auditing nonresident cases. Audit staff should balance the audit process to insure that the revenues of New York State are protected and at the same time economic activity by nonresidents in New York is not discouraged and that the burdens placed on taxpayers are neither unfair nor unreasonable.

Some of the most pressing questions asked by the Florida snowbird who is concerned about his domicile status have been:

* Should I quit the New York country club?

* Should I retain a Florida stock broker and discharge my New York stock broker?

* Can I still call upon my New York attorney for legal services?

* Can I still call upon my New York accountant to prepare my individual income tax returns?

* Do I have to close out all my New York bank accounts?

* Should I still see my New York doctor and dentist?

Unfortunately, the only clear-cut favorable answer is that the location of bank accounts and the fact that a taxpayer's individual income tax returns are prepared and filed in New York are not to be taken into account. The other areas remain "muddy".

Although the new guidelines are apt to be considered the "bible" by the domicile auditors, they do not have the precedential status of commission opinions or regulations. They should be viewed by the taxpayer and his representative as non-binding articulations of various issues by the Department.

What if the auditor challenges the retiree's change of domicile and a tax assessment is made? What recourse does the retiree or the retiree's estate have to contest the assessment?

In 1987, New York State established a new system for hearing tax disputes. Taxpayers now may, within 90 days from the time liability is assessed, request an informal conciliation conference conducted by the Conciliation and Mediation Services Bureau, or may request a hearing in the Division of Tax Appeals before an administrative law judge. No extensions of time are permitted. A conciliation order is binding on the Department, but is not binding on the taxpayer. Conciliation orders can be appealed to the Division of Tax Appeals. The administrative law judge will hear evidence and issue a determination within six months after the completion of the hearing or the submission of briefs, whichever is later. A determination by an administrative law judge can be appealed to the Tax Tribunal for review. The Tax Appeals Tribunal is independent of the Department, and hopefully will conduct an objective review. After reviewing the record of the hearing before the administrative law judge and any arguments, the Tribunal will affirm, reverse or modify the decision. The decisions of the Tax Tribunal are subject to judicial review by the taxpayer, but not by the Department. A taxpayer may seek judicial review by instituting an Article 78 proceeding in the Appellate Division of the New York State Supreme Court.

The details of the above procedures are outlined in a publication issued by the Department.⁽⁴⁾ Generally the provisions of the New York State Administrative Procedure Act apply to the proceedings.

Where the tax auditor challenges the retiree's change of domicile and the retiree receives a statutory notice of assessment, he probably will first seek relief from the Conciliation and Mediation Service Bureau and, if that is not successful, from the administrative law judge.

The conciliation conferee conducts the conference in an informal manner and must hear or receive testimony and evidence that he deems necessary or desirable for a just and equitable result. The orders of the Bureau are not required to be published and they are not considered precedent. In contrast, formal hearings are conducted before the administrative law judge. Prior to the hearing, motions may be made and either party may serve a demand for bills of particulars and request admissions. The administrative law judge may issue subpoenas to require the attendance of witnesses or production of evidence. At the hearing, the burden of proof is on the taxpayer. Decisions rendered by an administrative law judge are published. However, a determination issued by an administrative law judge is not to be cited, is not considered as precedent, and is not given any force or effect in any other proceedings conducted by the Division or in any judicial proceedings.⁽⁵⁾

Where the retiree has been filing Nonresident New York Income Tax Returns each year, the audit procedure is generally limited to the "open" three years. Where no such return has been filed, the audit can theoretically go back to the first year when the challenged change of domicile occurred. The tax may be assessed within six years after the return was filed if the retiree failed to report at least twenty-five percent of the adjusted gross income. There is also another serious concern. Even though a nonresident return has been filed by a retiree for many years, the auditor may take the position that no time limitation is applicable because all of the nonresident income tax returns that were filed by the retiree were fraudulent returns. For example, if it becomes evident during the audit that in each of the years when a nonresident return was filed the retiree was present in New York for more than 183 days, and some attempt was made by the retiree to hide that fact, the auditor may attempt to assess taxes from the date when the change of domicile is claimed to have occurred even though more than six years ago.⁽⁶⁾

Article 37 of the New York Tax Code treats tax law violations as Penal Law misdemeanors and felonies. Willful tax evasion, a Class E felony, is subject to fines up to $50,000 for individuals and jail terms up to four years.

The current interest rate for personal income tax is set by the Commissioner. Interest is compounded daily.⁽⁷⁾

There are a few additional points to bear in mind about the audit process:

* What if an auditor first notifies the tax-payer that his return is being audited two or three months before the statute of limitations expires. Under the Department's own 1997 manual an "audit is not to be commenced near the end of a statute of limitations period when an insufficient period of time remains to adequately address the issues of the audit" and as "a general rule, nonresident audits should not be started unless the auditor and the taxpayer have at least 120 days (without extending the assessment limitations period) to present and review material." Where an auditor requests an "unreasonable" extension of the statute of limitations, such request should be challenged. Frequently, an audit is for three calendar years and such a challenge may successfully eliminate one of the three years subject to the audit.

* What if the audit concedes that the tax-payer had become domiciled in Florida but claims the taxpayer has now changed his domicile back to New York? Who has the burden of proof? Assume that a husband and wife have effectively changed their domicile from New York to Florida and are in New York State only three months during the winter. After one of them dies, the surviving spouse spends close to six months in New York State each year and the auditor contends she is a New York resident. Does the surviving spouse have the burden of proof? No. The Department's manual states that no change of domicile back to New York will be recognized "until the weight of the activity and involvement in New York present a "clear and convincing" argument for New York domicile."

* What if an auditor stresses the fact that a New York bank account is kept open or the taxpayer sought advice from a New York professional. The manual states: "Our actions, as representatives of the State should encourage taxpayers to invest in New York by keeping bank accounts open in the state and to seek expert advice from varied professionals located in New York." It may be helpful to bring this statement of department policy to the auditors attention.

* Hopefully the auditor will confirm that there has been an effective change of domicile to Florida. It may be very helpful in a future audit if the auditor gives you a written verification of his conclusions during the audit process, including the depth of the audit conducted. If the auditor refuses to do so, point out that at page 61 of his own manual it states that such a verification should be provided.

CAUTION: The retiree should contact both his attorney and accountant immediately upon receiving any inquiries from any taxing authorities and they should review the most recent laws, regulations and cases relating to audit procedures.

1. If as a result of the audits, a substantial number of retirees decide to cut off all of their economic ties to New York State, the result may be less tax revenue rather than more revenue.

2. Prior to 1993, New York tax auditors employed various approaches in conducting domicile audits. In 1993, in an attempt to provide more uniformity, the New York Department of Taxation and Finance issued a comprehensive set of field audit guidelines. The 1993 version encountered substantial criticism and many changes were recommended by the New York Society of CPA's, the New York State Bar Association and individual professionals. As a result, a 92-page revision of the guidelines was issued in May, 1994.

3. Richard E. Gray v. Tax Appeals Tribunal, Appellate Division, Third Department (January 9, 1997).

4. N.Y. State Taxpayer's Guide, Publ. 42, Oct. 1987.

5. See Article 40 of the N.Y. Tax Law at Sec. 2000 et seq.

6. N.Y. Tax Law Sec. 683.

7. N.Y. Tax Law Sec. 697; See 20 NYCRR 2393.1(e)(2).