Living in a high-tax state? Explore the benefits of dual residency

What’s on your retirement wish list? Sandy beaches? Mountain views? How about a lower tax rate? Knowing whether you can live in one state and claim residency in another is key to minimizing your tax burden. Understanding tax residency and exploring the best states to retire in can significantly impact your financial future.

Millions of Americans are eligible to retire each year, and most start planning well ahead of their last clock-out. Choosing your state of residence is an important step in planning, as it has long-term tax and earnings implications.

The following factors can help you determine whether an out-of-state relocation is a smart financial move:

Why does residency matter?

States may impose their personal income taxes on an individual’s worldwide net income if they are a resident there, and they may also tax an individual’s net income from in-state sources if they are a nonresident there. If an individual resides in one state and has income from sources in a nonresident state, the residence state generally gives credit for taxes paid to the nonresident state.

Can you be a resident of two states? Domicile vs. residence

Hardly any of us use the term domicile in our day-to-day conversations, but it’s an important term in the tax world. Legally, you can have multiple residences in multiple states, but only one domicile. This raises the question: Can you be a resident of two states? Technically, yes, you can be domiciled in one state and be a statutory resident of another. But you can only have one domicile and that distinction matters enormously when it comes to taxes.

Domicile

Your domicile is your principal residence, true home or place you return to, often referred to as your permanent home or tax home. To maintain it, you must spend most of the year there and be able to prove it is the center of your life. Your other properties are considered residences, not a domicile.

To establish a domicile, you need compelling proof that you live and invest in the state — and tax authorities want more than just a mailing address or driver’s license. You’ll need to track time spent at the domicile compared to your other residence(s). Voter registration is another factor that can help establish your domicile.

As an example, let’s say a long-time Minnesota couple purchased a second home in Florida to use three months out of the year. Since the couple spends most of the year in Minnesota, it’s their domicile. They have a residence in Florida. If audited, tax authorities could investigate where the Minnesotans earn income, where their children attend school and where they belong to clubs or religious institutions to help determine their domicile. This process is known as a residency audit.

Establishing a domicile in a new state means you truly want to make a permanent and fulfilling life there.

Statutory resident

Remember, there are two ways that a person can be a tax resident of a state: domicile and statutory residency. An individual can be a statutory resident of a state if they have a place of abode (somewhere you can live year-round) and if they spend more than a specified number of days/year in the state (usually 183 or more).

The following table compares the concepts of domicile and residence:

	Domicile	Residence
Definition	Your permanent, true home — the place you intend to return to indefinitely	Any place of abode where you live or stay for a period of time, suitable for year-round living (three-season cabins won’t do)
How many can you have	Only one at a time	Multiple, across multiple states
Intent required	Yes, you must intend for it to be your permanent home	No, physical presence alone can establish residency
Tax implications	Your domicile state can tax all your income, regardless of where it’s earned	A residence state can tax income earned within that state but can tax all your income if you are a statutory resident
Proof required	Strong documentation of ties: time spent, voter registration, financial accounts, professional relationships and more	Place of abode — proof of year-round residence suitability Day count — personal calendars, location trackers such as TaxBird or Monaeo
Examples of establishing factors	Primary home, driver’s license, voter registration, community memberships and family location	Employer withheld personal income tax in the state, as evidence of the worker’s physical location there
Risk if mismanaged	Former state may dispute your domicile change and pursue back taxes	Exceeding day thresholds can trigger dual residency and double taxation

What is dual residency?

Dual residency occurs when an individual is considered a legal resident of two states simultaneously. This can happen intentionally, when someone splits time between a primary home and a second property in another state. Or, unintentionally, when a person exceeds a state’s day threshold without realizing it. Either way, being classified as a resident in two states means both states can assert the right to tax your income, which can lead to a significant and often avoidable financial burden.

It’s worth noting that dual residency is different from having a domicile in one state and a residence in another. You can only have one domicile — your permanent, true home — but you can have residences in multiple states. The risk arises when your time spent, financial ties or community connections in a second state are strong enough for that state to claim you as a resident too. Understanding where that line is drawn and staying well within it is critical to managing your overall tax exposure.

The parameters to determine residency

While each state sets its own residency rules, most use similar criteria to determine whether someone is a resident. The most commonly applied standard is the 183-day rule. Under the rule, if you spend more than 183 days in a state during the calendar year and if you have a place of abode (a living location that is suitable for year-round use), that state may consider you a resident, regardless of where your stated domicile is. Meticulous recordkeeping is essential to proving you’ve been in a state for less than 183 days, for purposes of disproving a statutory residency claim.

Day counts (time spent) are also relevant to determining if you are domiciled in the state, because they are perhaps the most important piece of evidence regarding how important that state is to your life. In addition to day counts, states look at a range of factors to assess your intent to make it your permanent home. Depending on what state you are in, these can include:

• Where you maintain your primary home
• Active involvement in a trade or business located in the state
• Family connections — where your spouse and dependents live
• The location of your personal and professional relationships (such as doctors, attorneys and accountants)
• Where you hold bank accounts and financial assets
• Where you are registered to vote
• Where your vehicles are registered and licensed
• Where you perform any hobbies
• Where your friends live and the location of other social connections
• The physical location of items near and dear to you (the teddy bear test)

The weight given to each factor varies by state, but collectively they paint a picture of where your life is truly anchored.

A residency audit, where a state tax authority investigates your connections to the state, can be triggered if there is any question about your domicile. Auditors may review travel records, credit card statements, phone records and even social media activity to determine where you actually spend your time. The more clearly your day-to-day life is centered in your claimed domicile state, the stronger your position will be.

Establishing state residency: A step-by-step process

Changing your state residency requires more than simply buying a home in that state. It requires intentional, documented actions that demonstrate your intent. Each state is different, but here are some of the steps that will help you build a defensible case for residency:

1. Write a domicile change narrative: If a state audits you for residency, they will ask for documentation of items such as those listed below. While states don’t ask for an underlying narrative that ties the items together, taxpayers can take proactive steps to craft this narrative on their own.
2. Purchase or lease a permanent home in the new state: This is the foundational step. Your new residence should be suitable as a year-round, primary home, not a vacation property.
3. Consider a declaration of domicile: Even though many states allow or require you to formally declare your intent to establish domicile, other states generally assign it low weight as it often appears self-serving.
4. Obtain a driver’s license in the new state: Update your license promptly. It is one of the first indicators that tax authorities examine.
5. Register your vehicles in the new state: Transfer vehicle titles and registration to align with your new domicile.
6. Register to vote in the new state: Voter registration is a strong indicator of what location you consider your permanent home.
7. Update your address with the IRS, Social Security Administration and financial institutions: Ensure all government agencies and financial accounts reflect your new state of residence.
8. Join community and civic organizations in the new state: Memberships in local clubs, religious institutions or professional associations reinforce your ties to the community.
9. Spend the required number of days in your new state: Track your time carefully to help ensure you do not exceed the allowable days in your former state. Even though domicile considerations do not involve a strict day count, the amount of time you spend in a state is one of the most influential pieces of evidence about your intent regarding your permanent home.
10. Maintain detailed records: Keep travel logs, receipts and any documentation that confirms where you are spending your time. This is a valuable defense in the event of a residency audit.

Tax implications of establishing your state domicile

Relocation is a complicated, personal decision. It can also be costly if you don’t plan for tax implications, such as income and estate taxes.

Income tax sourcing rules

The state where you are domiciled can tax your income, regardless of where you earn it. This makes the prospect of moving to a state with a lower tax rate (or to a no-tax state) more attractive for potential tax savings.

However, if you become a nonresident, a state can still tax the income you make from sources within the state. This is known as nonresident tax. Income earned from stock options, restricted stock awards or from pass-through business income reported on state K-1s can be sourced to a nonresident state.

If you’re thinking about selling a business, plan ahead. You can structure the sale to influence how income is eventually sourced.

Nonresident states generally can’t collect tax on the sale of stock, but they can tax sales of tangible property that’s located within the state, interests in partnerships that operate there or gains from installment sales of either.

To evaluate the state tax impact of moving, you need to understand the sourcing rules that apply to the income you would earn after a domicile change.

Estate tax

Some states have an estate tax exemption that’s lower than the federal allowance. When you pass away, your estate could avoid federal estate tax but not state tax. If your estate already exceeds the federal exemption, a change in location could mitigate any state estate tax that will be due.

Some states have much lower estate taxes than others, and some don’t have an estate tax. Carefully review estate tax laws before choosing a new domicile.

State pass-through entity taxes

Under current law, taxpayers with modified adjusted gross income (MAGI) of up to $500,000 may deduct up to $40,000 of state and local taxes (SALT) as an itemized deduction. For taxpayers with income above that threshold, the deduction is gradually reduced, though it cannot fall below $10,000. As a result, higher-income individuals may still bear a significant portion of their state’s individual income tax burden.

However, the SALT limitation does not apply at the business-entity level. As a result, all but five states with an individual income tax have enacted pass-through entity tax (PTET) regimes that allow owners of pass-through entities (e.g., S corporations, partnerships and LLCs) to pay state income tax at the entity level rather than individually. Because the tax is deducted by the entity, it is not subject to the individual SALT limitation, allowing owners to preserve a larger federal tax deduction and reducing the cost of living and doing business in higher-tax states.

Before moving to a new state, owners should investigate whether workaround elections are offered. A tax advisor can help you calculate the potential tax liability and the pros and cons of moving.

Current and future state tax liabilities

If you owe taxes, they don’t disappear when you leave. You could have trailing income from the state you’re exiting, too.

Your home state reserves the right to tax income if it’s related to work you performed or earned there. That includes deferred compensation, stock options, restricted stock units or other income that vests over time. If you sell a business, even in installment sales, the state where it’s located may tax you on the income.

On the other hand, nonresident states cannot tax intangible income, such as dividends, interest, stock sales and retirement income.

To quantify the financial benefit of moving to a new state, you have to understand what income will be sourced to your old state, what won’t and whether it’s worth the cost to you.

What happens when two states claim your residency?

Here’s how easily this can happen. Let’s say a retired couple is close to spending more than 183 days out of their domicile state. They planned to go back home, but now it’s Christmas, and they want to spend a few more days with their grandchildren.

They pass the 183-day mark and become statutory residents and owe taxes in two states. This situation can lead to double taxation.

In this situation, it is possible that each state will give credits for taxes paid to the other state on income sourced to the other state, meaning that out-of-state credits would be claimed on both returns. This issue is complex and varies across states, so caution is warranted.

Changing your state domicile is a personal decision. You may be able to save thousands of dollars in taxes, but at great personal cost (like being away from family or leaving a community you love). In the end, only you can decide whether it’s worth it.

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