19 06 2017

Address On Federal Return Creates State Income Tax Problem

People can be unpleasantly surprised when they find themselves hit with income tax by a state in which they were neither working nor living in the year in question. One of the reasons that happens is because of a concept called domicile. In today's mobile world, I think it may be an outdated concept, but you have to contend with Reilly's First Law of Tax Planning - " It is what it is. Deal with it ."

An Arkansas administrative hearing decision (17-402) is a good basic illustration of the issues and a cautionary tale for folks whose life is more ordinary than those featured in some of my domicile posts. Arkansas does not disclose the names of taxpayers in administrative hearing decisions, so I will call her Alice. You'll see why.

A Move

Alice had been a long term resident of Arkansas. She worked for a national reals estate management company that managed property in Arkansas until it lost a large contract. Alice decided that she like her job better than she liked living in Arkansas. That was in the fall of 2013. A year later the company lost another big contract and she found another job. In 2015 she moved back to Arkansas. She insists that she had no plan to return to Arkansas when she left in 2013. Nonetheless the Arkansas Department of Finance and Administration treated her as a resident of Arkansas concluding that she had not changed her domicile.

The Stickiness of Domicile

A lot of people think that determining your state of residence is a matter of day counting. This is understandable as many states have adopted the New York rule. If you have a permanent place of abode in New York and are physically present in the the state more than 183 days (and a day means any part of a day even a proverbial New York minute), you are a statutory resident. But a statutory resident of New York or Massachusetts, for example, will also be taxed as a resident of some other state for that entire year.

That is because you are always a resident of the state where you are domiciled even if you spend no time at all there in a given year. I constructed a hypothetical fellow called Harry Hedgefund. He is a dealmeister with offices in Manhattan in Boston. He has apartments in Greenwich Village and the South End, where his mistresses live. And he has a monstrous house in Alpine, NJ where his family lives. That means he is domiciled in New Jersey, but there are many days where he is in New York in the morning and Massachusetts in the evening making him a statutory resident of both states.

That's not Alice's problem. Alice's problem is that even though she packed her stuff in a U-Haul and left an "Alice doesn't live here anymore" note, she did not establish a new home anywhere else.

And she kept some significant ties with Arkansas. She kept her Arkansas drivers license and her car remained registered in Arkansas. There was one really big mistake though that was probably the main source of her problems.

Alice's Big Mistake

Alice's big mistake was that she filed her federal return using an Arkansas address. Her boyfriend testified about that.

He stated the Taxpayer has never lived with him in Arkansas. He explained that the Taxpayer utilized his address as a mailing address to have a single, stable address for her business records. He described the failure to transfer her car registration and driver's license to her new states of residence as an oversight. He asserted that the Taxpayer did not have an intent to evade taxes that were lawfully due.

Although the judge did not pick up on it the having "a single, stable address" was a damaging admission. It is not enough to decide that you are leaving your old domicile. You need to establish a new one.

The Taxpayer has not shown that she changed her domicile to another state before or during the 2014 tax year by a preponderance of the evidence due to the substantial ties that she retained with Arkansas after her move, specifically her Arkansas driver's license, vehicle registration, property tax assessments, and utilization of an Arkansas mailing address on all her business and tax records. Additionally, as stated above, the Arkansas Supreme Court has stated that acts must control over expressions of intent when a contradiction arises. The record shows that the Taxpayer was a domiciliary and resident of the State of Arkansas during the 2014 tax year.

The reason the address was such a big deal though is more practical than theoretical. The AICPA standards of tax practice forbid me from giving audit lottery advice, but you are not my client, so I'm telling you that if she had just used a different address it is highly improbable that Arkansas would have picked her up. Maybe they run the RMV data base against the tax return data base. Maybe they don't. But you know for sure they share information with the IRS.

On The Bright Side

The judge gave her a break on the penalty.

While it is concluded above that the Taxpayer did not sufficiently prove that she abandoned her domicile in Arkansas during her employment in and the Taxpayer did present significant evidence and testimony in support of her earnest belief that she did not qualify as an Arkansas Resident and sufficiently changed her domicile to ______ and ________. A preponderance of the evidence supports a finding that the Taxpayer's failure to file and pay her tax liability was due to reasonable cause and not willful neglect based on the record and the complexity of the issues involved. Consequently, the assessment of the failure to pay penalty and the failure to file penalty are not sustained for the 2014 tax year.

I think this case might be a more valuable cautionary tale than many of the others I have written about where very large stakes were involved and the taxpayers had sophisticated counsel. Alice seems to have been entirely blindsided and she might not be alone.