Three Common Problems in Handling a New York Residency Audit

By:
Mark Klein, JD
Published Date:
Oct 1, 2014

New York’s nonresident audit program continues to snag thousands of taxpayers who might—or might not—owe additional tax dollars to the state. Residency audits have reportedly generated more than $1 billion dollars for New York’s coffers, and hundreds of millions of dollars of new revenue is budgeted for the next year. Because taxpayers tend to fall into several traps that result in residency audits, the following tips can help improve their tax returns and better navigate a residency audit should they be faced with one.

Stick the Landing

New York taxes its residents on 100% of their worldwide income. A resident is defined as either:

  • A taxpayer who is domiciled in New York
  • A taxpayer who spends more than 183 days in New York and maintains a permanent place of abode there (i.e., “statutory residence”).

The New York City residency statutes are identical to those employed by New York State. Although these rules are fairly straightforward, the rules of domicile are anything but. In order to establish that a taxpayer moved from New York to Florida, for example, a taxpayer must demonstrate that she abandoned her old New York domicile and established a new domicile in Florida; this is known as the “leave and land” rule. Many people can successfully leave New York, but they must still pay tax to the Big Apple if they don’t “stick” the landing. In fact, in one reported case, a New York couple unquestionably left New York and traveled throughout the United States in a 34-foot motor home, with every intention of making their new home in another state. Although they specifically stated that they had no intention to ever return to New York, the state could still tax the couple because they had yet to land in a new location.

In order to land, a taxpayer must identify a specific date or event that triggered the intent to become a domiciliary of another state. Auditors often look for a major life event (e.g., marriage, divorce, retirement, new job) that sparked the intention to move. This intention must be coupled with physical presence in the new location. A taxpayer lamenting the snow of a Buffalo winter may have every intention of moving to Florida, but a change of domicile cannot occur until the taxpayer actually arrives there.


Join popular presenter Mark Klein, live, for a 2-hour CPE session on How to Handle a New York State Tax Audit: Soup to Nuts!, Oct. 21, 9-11am, at the FAE Learning Center, 14 Wall Street. If you can’t attend in-person, ask your questions via live video webcast. Find out more here. Find out more here.

No One Moves on January 1

Another problem in a number of residency audits stems from the landing date reported by taxpayers as the date that they changed their domicile. This is the date that is reflected on the tax return. For a number of reasons, often expediency, tax preparers might take the position that a taxpayer established domicile in a new location effective January 1 of a particular year. This eliminates the need for a part-resident/part-nonresident return, as well as the need to prorate and allocate certain types of income. It is unquestionably much easier, but it is a trap.

Most auditors start their inquiry about a change of residence with a simple question: “What day did the moving van arrive at the new location?” From an auditor’s perspective, this makes eminent sense: when taxpayers move, all the objects from their old homes are put into a large truck, which is driven to a new location. Once the goods arrive, the taxpayers have “moved” to their new homes. Many clients have significant wealth, however, and they can afford several homes and plenty of belongings. As a result, a moving van is often unnecessary because taxpayers might have each of their homes already furnished to their liking.

A return that claims a change of domicile on January 1 often generates the following question from the auditor: “How did you find a mover willing to work on New Year’s Day?” Of course, the answer is that there was no moving van; the client’s new home was already completely furnished. The auditor will then ask, “Where did the taxpayer spend New Year’s Eve?” Assuming the answer is that he was at his new home in Florida, the next question the auditor will ask is, “Where did the taxpayer spend New Year’s Day?” The answer is still Florida. But now there’s a problem. How did the taxpayer move to Florida between the time he put his head on the pillow in his Florida home and when he woke up in the same place? Nothing has “moved,” not even the taxpayer. The answer is obvious: this is not the date that domicile changed. More importantly, this claim has undercut the credibility of a tax return that states, under penalty of perjury, that the taxpayer moved on January 1. From the auditor’s perspective, the taxpayer and the tax preparer have just admitted that one of the most important facts on the tax return is wrong, and this will only make the auditor wonder what else is incorrect—not a great way to begin an audit.

Statutory Residence Trumps Domicile

A third trap for many practitioners is the failure to appreciate that the statutory residence rules supersede the rules relating to domicile. In other words, a taxpayer is incapable of changing her tax residence from New York in a year where she spends more than 183 days in New York and maintains an abode there for more than 11 months.

This problem can arise in a number of contexts. Assume that a taxpayer is about to enjoy a large capital gain from the sale of some stock purchased many years ago. She knows that the combined New York City and New York State income tax rates can exceed 12%, but that states like Florida, Texas, and Nevada have no income tax. As a result, the taxpayer leaves New York, uses a moving van to move most of her belongings, and lands in Texas by September 15. She enrolls her children in Texas schools, gets a job in Texas, and doesn’t return to New York for years. The New York home is kept for the occasional “getaway weekend,” and it contains just a few essential items of furniture. On December 1, when the taxpayer is unquestionably a Texan, she sells her stock.

Many practitioners would treat this taxpayer as a part-year New York resident since she resided in New York until September 15, and in Texas thereafter. And, not surprisingly, the stock sale would be excluded from the New York return since it occurred after the change of domicile. Unfortunately for the taxpayer (and possibly the tax preparer), there is a very good chance that New York will still get 100% of the December 1 gain even though the taxpayer became a Texan on September 15. This is because, in the eyes of an auditor, the taxpayer was still a statutory resident of New York during the calendar year of the sale. Because the taxpayer started the year living in New York, she most likely spent more than 183 days in the state by July or August of the year of the stock sale. And, because the taxpayer had living quarters available to her for the entire year, she triggered the application of the statutory resident rules. Although domiciled in Texas, the taxpayer was a New York tax resident for the entire year. There is no proportionate reduction in the 183-day rule for part-year residents.

The solution to this problem is simple. If the taxpayer had waited until January of the next calendar year to sell her stock, none of the gain would have been subject to tax. Of course, this assumes that the taxpayer only returned to New York for the occasional getaway weekend and was not in New York for more than 183 days in the next calendar year.

Important Implications

Residency audits—some of the most intrusive audits imaginable—are becoming more and more common. Taxpayers often have the burden to prove their physical location every day of each year under audit. As discussed above, tax advisors must be sure of the nuances of the residency rules, because the consequences of ignorance can get very expensive for their taxpayer client. Awareness of these three important common issues will help ensure that a client is in the best position possible when the auditor knocks on the door.


Mark Klein, JDMark Klein, JD, is a partner at HodgsonRuss LLP, where he concentrates on New York State and New York City tax matters. He has more than 30 years of experience with federal, multistate, state, and local taxation. He also teaches courses on state taxation and tax practice and procedure for the University at Buffalo School of Management’s tax certificate program, is a member of The CPA Journal editorial board, and has written extensively on multistate taxation. He obtained his JD from SUNY Buffalo Law School. He can be reached at MKlein@hodgsonruss.com.

 
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