How Change-of-Domicile Strategies are Transforming Income and Estate Planning. Bachir P. Karam September 12, 2017

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1 How Change-of-Domicile Strategies are Transforming Income and Estate Planning Bachir P. Karam September 12, 2017

2 Overview A client s connection to one or more states can make a substantial difference in the amount of tax due on the client s assets. Many states impose substantial income taxes, with highest earning residents of New York City paying % and of New Jersey paying 8.97%. Some states also impose substantial state estate taxes, including New York (16%).

3 Overview Continued In contrast, certain states, such as Florida, Nevada, South Dakota, Texas, Alaska and Wyoming, do not impose any income tax or estate tax. Many of these same states also offer more flexible laws regarding administration of trusts. While a change in residence may seem straightforward, careful planning steps should be taken to ensure that the client has sufficiently cut ties with his or her former state.

4 State Comparison Income Tax Rate Estate Tax Rate New York New Jersey Connecticut Illinois California Florida Nevada S. Dakota Texas Alaska Wyoming %* 8.97% 6.99% 4.95% 13.3% 0% 16% 16%** 12% 16% 0% 0% * New York State rate of 8.82% plus additional New York City rate of 3.876%. ** No estate tax in New Jersey beginning in 2018; however, inheritance tax of 16% will continue to be imposed on certain testamentary transfers.

5 Sourcing of Income Most states tax income sourced from their respective states, even when earned by a nonresident. The significant distinction is that all income earned by a resident is taxed, whereas taxation of nonresidents is limited to income sourced to the taxing state. The key is demonstrating that one is no longer a resident of one s former home state.

6 Tax Residency Tests An individual can be deemed a resident of a particular state by one of two methods: the mechanical day count test or the subjective domicile test.

7 Day Count Test With minor variations, most states apply the same day count test : An individual who maintains a permanent place of abode for substantially all of the tax year in the state, and spends over 183 days in the state, is a resident, regardless of domicile. If an individual spends over 183 days in the state and maintains a permanent place of abode there for part of the year, he or she may be considered a part-year resident. Even a part of the day counts as a full day. Vacation home may be considered a permanent place of abode.

8 Day Count Test Exceptions Place of abode must be a dwelling place and must be maintained for substantially all of the tax year Presence in the State may be disregarded if solely to travel outside the State Presence also disregarded for in-patient treatment (i.e., nursing home) But out-patient treatment likely would count as a full day

9 Domicile: Presence and Intent Regardless of an individual s day count, he or she can also be deemed a resident of a state if he or she is domiciled there. Domicile consists of two elements: (i) physical presence in a jurisdiction and (ii) present intention to return to such jurisdiction whenever absent. A person s domicile is her true home the place which serves as the center of her domestic, social and work life and where she intends to remain indefinitely.

10 Significant Factors Domicile is a matter of common law. The test for determining a person s domicile is subjective and focuses on many factors, including: Where the individual has residences and where he or she makes his or her home (including whether each residence is owned or rented). The relative size and quality of the individual s respective residences. The location of heirlooms, prized personal possessions, and items of daily use, including automobiles.

11 Significant Factors Continued Which location is the nexus of the individual s social, civil, and professional life, and of his or her financial and business affairs. Where the individual or members of his immediate family are enrolled in school. Declarations of residency on official documents, such as tax returns. Where the individual is registered to vote and how often and recently he or she has voted there. Whether the individual obtains a driver s license in his new state.

12 Domicile Estate Tax The only relevant test for estate tax is the domicile test counting days is irrelevant. The common law determination of domicile is identical for income and estate taxation.

13 Domicile - Exceptions An individual who is domiciled in New Jersey or New York will nevertheless be considered a nonresident for income tax purposes if he or she maintains no permanent place of abode in such state, maintains a permanent place of abode elsewhere, and spends not more than 30 days of the year in such state. Nursing Homes

14 Establishing Domicile While it is critically important to break domicile under one s former home state, it also is necessary to positively establish domicile in the new state. An individual can qualify for the benefits of various Florida programs, including the homestead exemption, by making certain state and local filings.

15 Audit Process Residency audits may take months or longer. Meticulous record keeping is critical. If the taxpayer prevails, as a practical matter, he or she may not be audited again for several years, but there is no guarantee. If the taxpayer does not prevail, statutory interest likely would be added to the tax liability.

16 Practical Strategies: The Day Count To avoid qualifying as a statutory resident of their former home state, clients should: Count even the briefest visit to the former home state as a full day; Install tracking software on their cell phones, such as Monaeo; Keep a contemporaneous log of their movements via calendars, diaries, airline tickets, flight logs, car service receipts, phone bills, credit card slips, ATM slips, etc.; Use their credit cards daily in physical locations in their new home state to develop a record of continuous presence; and Avoid false positives.

17 Practical Strategies: Demonstrating Intent To avoid qualifying as a domiciliary of their former home state, clients should: If possible, sell any real estate in the former home state. Move near and dear items and valuables from the former home state to the new state. Use movers and keep the moving records and inventory sheets. Cancel driver s license and vehicle registrations in the former home state and obtain them in the new state. Change estate planning documents to specify the new state as the state of domicile. Obtain a safe deposit box in the new state and surrender any box in their former home state.

18 Practical Strategies: Demonstrating Intent Continued Use the new address for bills, documents, registrations, accounts, etc., and avoid any use of the old address. Obtain a bank account in the new state and use checks bearing the new address to pay bills, even when in their former home state. To the extent feasible, move business operations from the former home state to the new state. Resign from clubs and boards in former home state and join similar organizations in the new state. Notify any organizations to which the client belonged in the former home state of the move. Correct listings in membership directories.

19 Practical Strategies: Demonstrating Intent Continued Send change of address notices to friends, business acquaintances, banks, vendors and others as appropriate and keep copies of the letters and any responses. Purchase memberships or season tickets to theaters, sports teams, museums and other local performance-related activities in the new state (and let lapse any subscriptions for similar activities in the former home state). File a change of address notice with the U.S. Postal Service. Join a religious congregation in the new state and consider withdrawing from those in the former home state. Use the new address on tax filings and file a change of residence notice with the final resident tax return made to the former home state. Change the designation of primary residence on any insurance policies.

20 Practical Strategies: Demonstrating Intent Register to vote in the new state, and renounce the right to vote in former home state. When receiving medical care, see physicians in the new state, rather than physicians located in their home state, and arrange for medical files to be transferred to new healthcare providers. Purchase a burial plot in the new state. Spend holidays at the home in the new state. Enroll any minor children in school in the new state. Continued

21 Avoiding Ancillary Probate If an individual dies with real property or tangible personal property in his or her former home state, he or she may be subject to ancillary probate and estate taxes in that state. The most common approach to avoid ancillary probate is to transfer real estate to a revocable trust during the individual s life. However, it is likely that estate tax may still be imposed by the relevant state on such property.

22 Trust Residency Trusts are taxed by the state of their residence, as defined by applicable state law. As a general matter, a trust is considered a resident trust if: It was created under the will of a domiciliary of that state; It was irrevocable when created and was funded by a domiciliary of that state; It is a revocable trust created and funded by a domiciliary of that state; or It was revocable when created but subsequently became irrevocable, and, at the time the trust became irrevocable, the individual funding the trust was a domiciliary of that state.

23 Trust Decanting Even if a trust is irrevocable, it may be possible to modify the terms of a trust by decanting it into a new trust. Unless the indenture makes explicit provision for decanting, the trust s jurisdiction of governing law must permit trust decanting as a matter of law. Trust situs for purposes of construction and administration is determined separately from trust residence for tax purposes. Although decanting may not affect the tax residency of a trust, it may provide significant administrative benefits.

24 Benefits of Trust Decanting Decanting permits a Trustee to: Modify administrative provisions of the trust that may have become burdensome or obsolete; Change ages of distribution for asset protection or other purposes; or Take advantage of modern statutory developments, including: Silent Trusts; Dynasty Trusts; and Directed Trusts.

25 Closing Thoughts Income tax planning may become one of the most important services an estate planning practitioner can provide to clients. Changing state of residency may save a client and his or her family members a significant amount of tax. Careful planning and meticulous record-keeping is critical when planning a change in residency.