The so-called “Millionaire’s Tax” is likely to be on the ballot for Massachusetts voters in 2022. This proposed legislation would impose an additional 4% tax on earnings above $1,000,000 beginning in 2023. Before high earners consider relocating, they should be aware that even nonresidents must pay tax on income from Massachusetts sources. Those who do relocate may well be selected for an income tax audit after declaring a change in domicile.
The Massachusetts Department of Revenue (DOR) usually has a window of three years to complete an audit after a taxpayer files a return. To be prepared for this possibility, keeping thorough and accurate records is imperative. It is also important to understand how the DOR audits changes of residency.
The DOR uses two alternative tests to determine whether someone is a Massachusetts resident.
Statutory residency: If you have a permanent “abode” (home) in the state and spend more than 183 days in a calendar year here, the DOR classifies you as a resident of Massachusetts. “Abode” is broadly defined and could be a house, condominium, or apartment – virtually any structure with plumbing. Spending even one minute of a day in Massachusetts will count towards that 183-day total. Be mindful of this when booking flights that arrive late in the evening. Apps such as Monaeo, TaxDay, or TaxBird can assist with tracking this information. This statutory residency test leaves little room for interpretation and will be among the first things an auditor will review.
Domicile: The DOR also treats Massachusetts “domiciliaries” as residents, but the rule for determining a taxpayer’s domicile is not nearly as clear-cut as the rule for statutory residency. Changing domicile requires physical presence in a new location and the intent to make that place your home. Because auditors cannot know or prove your intent, they look to indicators such as your social, civic, work, and family commitments in one location or another.
Taxpayers facing a domicile audit need to document their ties to their new home and the circumstances that led them there. JDJ is in a unique position to help clients with this. Our familiarity with our clients’ lives, including their families and businesses, enables us to assist with planning for residency changes, anticipate questions that a skeptical DOR auditor may pose, and maintain the paperwork that an auditor may eventually request. When working with clients who are planning a move out of state, JDJ utilizes an extensive checklist to proactively prepare for the possibility of an audit. For example, we suggest that clients register to vote and procure a driver’s license and relevant professional licenses in their new home state. Legal addresses for bank and brokerage accounts, credit cards, insurance policies, and estate documents should be updated to reflect the move. Joining local clubs and religious organizations and establishing relationships with physicians in their new area is also important. JDJ can preserve helpful documentation showing clients’ ties to their new home, such as expenditures for a well-equipped home office, or tuition payments at local schools for their children. Memorializing such ties before a move can save time and frustration later, if the DOR does commence an audit.
Steps in the audit process include:
- Desk audit: The taxpayer receives a letter requesting extensive information, including, but not limited to the following: domicile questionnaire, physical presence calendar, various tax forms, W-2s, 1099s, bank statements, real estate tax bills, homeowner and life insurance policies, and even cell phone bills. This documentation is critical to proving a change in residency, so keeping thorough, detailed records is imperative. JDJ maintains complete records of all invoices, insurance policies, statements, and tax bills on behalf of our clients, so we can gather, organize, preserve, and produce this information when needed. Taxpayers under audit bear the burden of proving a change of domicile, and it is much easier to keep good records contemporaneously than to search for them after two or three years have already passed.
- Appeal: Assuming that the desk auditor challenges a change of domicile, the taxpayer may appeal this determination to an appeals officer within DOR. The taxpayer’s legal counsel may recommend that the taxpayer participate in the appeals conference. In some cases, taxpayers may be able to negotiate a settlement in which DOR acknowledges the taxpayer’s change of domicile as of a certain date, in exchange for payment of a portion of the tax in dispute. This is no guarantee against future audits, but it is as close as one can get. The appeals process generally takes several months, or longer. Taxpayers who have maintained good records can expedite the process by providing the requested information promptly to the DOR.
- Trial Phase: If a taxpayer chooses to dispute the decision of the appeals process, the next step is litigation, which would culminate in a hearing before a member of the Appellate Tax Board. The Appellate Tax Board consists of five members appointed by the governor who serve essentially as judges who hear and decide state tax cases. Again, taxpayers have the burden of proving any change in residency, and here, a taxpayer’s credibility is crucial. Taxpayers have the opportunity to explain their move in their own words, and if their documentation supports what they say, then the Board may eventually acknowledge their change of domicile. Like most litigation, however, the process can be risky, time‑consuming, and expensive.
The bottom line – if you are considering moving out of Massachusetts, whether because of the “Millionaire’s Tax,” or you have had enough of New England winters, or simply because your life is leading you to a new home, be sure to save yourself time and frustration by planning ahead. Memorializing your move as it happens will put you in the best possible position if you undergo an audit.
More information about Massachusetts residency status is available at https://www.mass.gov/service-details/learn-about-legal-and-residency-status-in-massachusetts
It is important to consult with qualified professionals and do careful, thoughtful planning in order to understand the pros and cons of any decision. As always, JDJ stands ready to assist its clients with their tax planning needs.