Is It A Bad Thing To Be A Resident Of Two States At The Same Time?

A state tax issue came up with a client recently, and I was somewhat surprised by another CPA’s response.  The issue arises when someone has tons of interest and dividend income – that is, big bucks, laden with loot, banking the Benjamins.  Since I consider myself a future lottery winner, it also means something to me.

Here it is:

           

Can you be a resident of two states at the same time?

The other CPA did not think it possible.

There are a couple of terms in this area that we should review: domicile and place of abode. Granted in most cases they would mean the same thing. For the average person domicile is where you live. You are a resident of where your domicile is located. We future lottery winners however frequently will have multiple homes.   I intend to have a winter home (New Mexico comes to mind), a summer home (I am thinking Hawaii) and, of course, one or more homes overseas. Which one is my domicile? Now the issue is not so clear-cut.

OBSERVATION: Let’s be honest: this is a high-end tax problem.

Domicile is your permanent home. It is the place to which you intend to return when absent, to which your memories return when away, it is home and hearth, raising children, Christmas mornings and planting young trees There can be only one. A domicile exists until it is superseded, and there can never be two concurrent domiciles. It is Ithaca to Odysseus. It took Odysseus ten years to get home from Troy, but his domicile was always Ithaca. The concept borders on the mystical.

A place of abode can be an apartment, a cottage, a yacht, a detached single-family residence. There can be more than one. I intend to have abodes in New Mexico, Hawaii and possibly Ireland. My wife may pick out another one or two.

Most states (approximately 30, I believe) use the concept of “domicile” to determine whether you are or are not a “resident” of the state. You can generally plan for these states by pinning down someone’s “main” house.  A state can tax all the income of a resident, which is what sets up the tax issue we are talking about.

Then you have the “statutory” states, among the most aggressive of which is New York. New York will consider you a resident if:

(a)  Your domicile is New York, or

(b) Your domicile is not New York, but

a.     You maintain a permanent abode in New York for more than 11 months of the year, and

b.     You spend more than 183 days in New York during the year

That “or” is not there because New York wants to be your friend. That (b) is referred to as statutory residency. It is intentional, and its intent is to lift your wallet.

How? It has to do with all those interest and dividends we future lottery winners will someday have.

Let’s say that you live in Connecticut and work in White Plains. You are going to easily meet the “more than 183 days in New York” test. Unless you work at home. A lot. Let’s say you don’t.

We next have to review if you have a “permanent abode.” What if you have a vacation home in the Hamptons. What if you have an apartment in Brooklyn. What if you rent an apartment (in your name) for your daughter while she is attending Syracuse University. Do you have a permanent abode in New York? You bet you do. The “permanent” just means that it can be used over four seasons. We already discussed the meaning of “abode.”

Think about that for a moment. You may never stay at your daughter’s apartment. It will however be enough for New York to drag you in as a statutory resident because you “maintain” it.  New York doesn’t care if you ever actually stay there – or even step foot in it.

Great. You are a resident of both Connecticut and New York.

So what, you think. Connecticut will give you a credit for taxes paid New York. New York will give you a credit for taxes paid Connecticut. The accountants’ fee will be wicked, but you are not otherwise “out” anything, right?

Wrong. You may be “out” a lot, and it has to do with those interest and dividends and royalties and capital gains – that is, your “investment income.”

There is a state tax concept called “mobilia sequuntur personam.” It means “movables follow the person,” and in the tax universe it means that movable income (think investment income, which can be “moved” to anywhere on the planet) is taxed only by one’s state of residence. The system works well enough when there is only one state in the picture. It may not work so well when there are two states.

The reason is the common technical wording for the state resident tax credit. Let’s look at New York’s wording as our example:

A resident shall be allowed a credit …for any income tax imposed for the taxable year by another state …. upon income both derived therefrom and subject to tax under this article."

The trap here is the phrase “derived therefrom.” Let’s trudge through a New York tax Regulation to see this jargon in its natural environment:

           

The term income derived from sources within another state … is construed as ... compensation for personal services performed in the other jurisdiction, income from a trade, business or profession carried on in the other jurisdiction, and income from real or tangible personal property situated in the other jurisdiction."

Well, isn’t that a peach? New York wants my interest and dividend income to be from personal services I perform (that’s a “no”), from a trade, business or profession (another “no”) or from real or tangible property (again a “no”).

New York will not give me a resident credit for taxes paid Connecticut.

That means double state taxation. 

Yippee.

Can this be constitutional? Yes, unfortunately. The Supreme Court long ago decided that the constitution does not prohibit two states reaching the conclusion that each is the taxpayer’s state of residence. The Court stated:

“[n]either the Fourteenth Amendment nor the full faith and credit clause … requires uniformity of different States as to the place of domicile, where the exertion of state power is dependent upon domicile within its boundaries.” (Worcester County Trust Co v Riley)

What did we advise? The obvious advice: do NOT be in New York for more than 183 days in a calendar year NO MATTER WHAT. 

Our client’s apartment is in Manhattan, so she also gets to pay taxes to New York City on top of the taxes to New York State. I hope she really likes that apartment.

BTW New York is NOT on my list of states for when that future lottery comes in.

Did You Hear That Spain Is Taxing The Sun?

It has been a while since we have played “Are They Smarter Than a Garden Gnome?” Our blog today involves a near-bankrupt government, which pressed the metal to the floor with “renewable energy” and “green” subsidies. It has now taken the preposterous – and possibly first-time-in-human-history- act of taxing the sun.

You think I am kidding. You may also think I am talking about the United States, but I am not. At least, not this time.

We are talking about Spain, one of the sunniest places in all of Europe. It is a likely candidate for photovoltaic and solar-thermal power generation – that is, solar panels. It sounds good on first hearing. That of course is before the government got involved.

In 2007 Spain had 701 megawatts of installed solar panels. I do not know if that is a lot, but I do know that the Spanish government wanted to increase the amount. Not having a Solyndra or Satcon Technology on which to throw away tax money, they decided to push solar power.  That meant that they paid more for solar-produced power than for other power – think coal, hydroelectric, nuclear, air draft from flocks of geese. How much more? Think 12 times more than conventional power. Yipes! The government was unwilling to pass the full cost onto the populace, even though Spanish power producers have some of the highest rates in the EU. The government instead ran up subsidy deficits now totaling 26 billion euros.

Well, they did increase solar power generation. Current production is 4,000MW, which is an impressive increase from 701MW in 2007.  

What could possibly go wrong with subsidizing solar? After all, it is renewable, environmentally sustainable and so forth.  

Well, when you are paying 12 times more than something is worth, you better not buy too much of it. Unfortunately, Spain missed this lecture. The Spanish government has its fingers all into and over its energy industry. There are mandates for clean energy, for idle gas-fired plants, for poor families and for island dwellers. As a consequence, the government is now about 35 billion euro in the hole from its subsidies. To exacerbate matters, Spain is entering its second recession in three years. The government has recently announced spending cuts and tax increases of 100 billion euros. Unemployment has reached 25 percent. Spain, strapped for cash, is now looking to cut back.

What to do, what to do?

Got it! Spain will tax the electricity produced by home solar panels. Homeowners will have to connect their panels to the grid so their production can be metered – and billed back to them, of course. The effect is to make self-generated power more expensive than power purchased from the grid. 

How much more are we talking about for an average Spanish household? Approximately 27 percent more.

Spain’s Industry Ministry justified this action by explaining that – even though you may be self-sufficient – you “benefit” by having the back up provided by the power grid. Not everyone will be affected, however – only those Spaniards living within reach of the power grid. If you live in remote areas, you will be untouched by this.

Oh, well. Maybe you can sell your power back to the grid and offset somewhat this new cost. No can do. Spain will not allow that. You will have to move to Germany if you want to sell your excess power.

What if you refuse to connect to the grid? Spain reserves the right to fine you up to 30 million euros. Yipes! There has been pushback by consumer groups clarifying that this fine was created in 1997 by a law intended for large corporations, not private individuals. Someone will have to take that theory to court, however, to test how sound it is. I can assure you that it would not be me.

The sad part is that there is nothing here that a clear-headed person could not have seen coming from a mile away, or at least since 2007. Every government benefit given in turn is taken from someone else. This is the economics of taxation, and in the end economics won out. The Spanish government is now scrambling to keep all the spinning dishes from hitting the ground.

What do you think: are they smarter than a garden gnome?

Has The IRS Noticed You?

My partner asked me today whether I thought we are seeing more tax notices. We are pretty keen on this issue, as tax notices – any tax notice – reflect badly on the quality of our work.  I would begin to question my dentist if I routinely received notices from the Internal Dental Service, the Ohio and Kentucky Departments of Dentistry, the Cincinnati Dentistry Division, …. You get the idea.

Have you heard about the IRS’ recent fishing expedition? It is called “Notification of Possible Income Underreporting.” There’s a name. Why don’t they just bash down your door and arrest you? 

What is causing this is the use of debit and credit cards. The payment settlement entities (think Visa) and third-party payers (think PayPal) are now required to relay financial data to the IRS via Forms 1099-K. The IRS has their nose into how much you are depositing into your business checking account. You can pretty much guess that the IRS is matching A to B and is sending out letters when they do not match.

There are four possible letters the IRS may send, each requiring its own response:

1. Letter 5035 – the softest of the letters. You do not need to respond.
2. Letter 5036 – you want to respond within 30 days as the IRS reserves the right to assess you.
3. Letter 5039 - you now need to complete yet another form – Form 14220 Verification of Reported Income. Lucky you.
4. Letter 5043 – if you believe that the return you filed is accurate, then you must provide the IRS with a written explanation of why you believe that. (Think about that sentence for a minute).  Again, failure to respond may trigger an assessment.

Now, a normal person would anticipate that the IRS would compare what a business reports as gross revenue to the 1099-K.  As long as the first number equals or exceeds the second, all should be OK.

Oh, to be young and naive.

That is NOT what the IRS is doing.

How can the numbers go awry? Well, a couple of very common transactions come immediately to mind: 

• The 1099-K “sales” will include sales taxes. Generally speaking, accountants do not include sales taxes in “sales,” primarily because sales taxes are not sales. A business collects sales taxes as an “agent” and is required to remit them to the state tax department. Does this sound like “sales” to you?
• The 1099-K includes cash draws by the customer. Say you buy something and take an extra $20 in cash. Again, most accountants would not report that transaction as a “sale.” Same reason as (1).

The IRS has created an alternate universe. How? Well, they did a study, apparently super-secret and better concealed than donor lists to Section 501(c)(4) nonprofit applicants or the tax records of the American Issues Project. This study has determined sales levels for different lines of business – dry cleaners, florists and so forth – as well as “average” proportions of debit and credit card sales to total sales. The IRS has one piece of this information – the debit and credit cards – so now it backs into expected sales (based on averages). If you report lower sales than that… BAM!... here’s your letter.

Why does this upset me?

(1)  This exercise is based on averages. The IRS is wasting a taxpayer’s time because somebody-who-knows-somebody-overheard-somebody-talking-about…. You get the idea. It would waste less time and possibly be cheaper for the government to just mug the taxpayer.

(2)  How much of a tax professional’s time – my time –are they wasting? Can I even bill for this nonsense? Last time I checked, the IRS is still not sending me a paycheck. Maybe I should start invoicing them.

(3)    Understand what the IRS is doing here: they are shifting an examination function onto the shoulders of the taxpayer and his/her tax advisor. The IRS can potentially ask for anything: maybe the name of the church you attend. It can then conduct a “study” to determine average donations to that church. Guess what? If you exceed that amount, get ready for a notice. Where does this end? If the IRS wants to examine you, then let them examine you! At least they would have skin in the game, as they would have to pay the examiner’s salary. Perhaps that would cool their heels a bit.  

(4)    The backbone of our tax system has been voluntary compliance. As the nation becomes increasingly bankrupt, the “voluntary” part is becoming laughable. The government – enforcing through the IRS – is forever wringing us for more information: for FBARS, for cost basis on the mutual fund you sold, for the tax ID number of your child’s day care, for foreign bank reporting (FATCA) on your account overseas.

Think about that last one. How would you feel if Japan required all U.S. banks to report to Japan on accounts owned here by Japanese citizens? And – to put the cherry on the sundae – slap a 30% tax on any U.S. bank obstinate enough to not comply with Japan’s decree? I tell you what I would do if I were a bank president: I would not accept accounts from Japanese citizens. Guess what foreign banks are doing to American expats. Congratulations, you are smarter than an average U.S. Representative or Senator.

Going back to my partner’s question: yes, we are seeing more notices these days, because almost every year the IRS finds new ones to send out.

Goodness knows what they will trot out next year.