Understanding State Residency Rules for Income Tax Purposes

September 12, 2023—Understanding state residency rules as an income tax planning strategy may be important for people who live in more than one state. But these rules can be complicated and tend to vary across states. Moreover, the state residency rules for trusts can be even more complex. In this podcast, Tom Kelley, national director of Income Tax Planning for Wilmington Trust Emerald Family Office & Advisory®, deciphers some of the tests states may use to determine residency for both individuals and trusts, and he offers insights on how to potentially navigate the complexities of these state-specific regulations.

Hi, thank you for tuning into today’s Emerald GEM, which stands for Get Educated in Minutes. I’m Tom Kelley, national director of Income Tax Planning for Wilmington Trust’s Emerald Family Office & Advisory® and your host for today’s podcast. In today’s GEM I’m going to discuss what individuals and families need to know when considering a change in state residency and when creating trusts for state income tax purposes. I will highlight tests that are used as well as additional factors that are applied as part of the analysis. Just as a reminder, Wilmington Trust does not provide legal, accounting, and tax advice. This discussion is for illustrative purposes only, and would be subject to any opinions and advice of your own attorney, tax advisor, or other professional advisor.

We’ll start with the state income taxation for individuals and families, specifically identifying and understanding the two tests that are used: a state’s residency test and its domicile test. Some taxpayers may be familiar with the first test, which is the state’s residency test, that states may apply in which an individual may need to be removed from the current home state or reside in another state for 183 days or more.¹  While it sounds simple, a state may qualify this test with an additional factor or factors, such as the timing of being present on a certain day. For example, the state of Maryland indicates that “an individual is a resident of Maryland if the individual is domiciled in Maryland on the last day of the taxable year or if the individual maintains a place of abode in Maryland for more than six months of the taxable year and is physically present in the state for 183 days or more during the taxable year.”²

Therefore, taxpayers should cautiously evaluate their own particular state’s statutory definition of a resident as counting days may not be enough to pass the residency test.

If the residency test is met, individuals and families then evaluate and analyze the second test which is the domicile test. The domicile test is more complex and involves both intent and action. Domicile means the place where an individual has a true, fixed permanent home and principal establishment, and to which place, whenever absent, the individual has the intention of returning. In many cases, a determination must be made as to when or whether a domicile has been abandoned. Further, a mere intent to treat a place as the person’s domicile is not enough. Intent must be supported by action. Ties must be created with the new domicile while severing ties with the old domicile.

Words such as abandoning and severing a current or soon to be former resident state are strong indication that several actionable items must take place. Let’s look at some of the criteria that may be evaluated:

1. Where does the person now live?
2. Where is that person registered to vote?
3. In which state are motor vehicles registered?
4. Where are business interests conducted?
5. Where are property interests located?
6. Where are social, community, and religious ties?
7. Do legal documents indicate an establishment of resident in the new state?

In short summary, to determine state residency for income tax purposes, two tests must be passed. Given the complexity of both tests, taxpayers may consider working closely with an experienced advisor to ensure all of the requirements are successfully met.

Now that we’ve discussed what individuals and families need to know when considering a change in state residency, let’s discuss the state income tax residency factors for trusts, specifically irrevocable non-grantor trusts.

Please note many individuals create what are known as revocable trusts for a number of planning reasons. Generally, revocable trusts are what we call disregarded entities for income tax purposes and thus all income, gains, deductions, and credits are reported directly to and by the creator of the trust. These types of trusts are not part of our discussion. Also, certain irrevocable trusts are not treated separately as tax entities. These are often referred to as grantor irrevocable trusts, and they have the same income tax treatment as the previously mentioned revocable trusts and therefore are also not part of our discussion. We are specifically only talking about irrevocable non-grantor trusts that are recognized as their own taxable entities.

Now, for individual taxpayers, we talked about where one lives or intends to have a permanent fixed, true home, etc. For the irrevocable non-grantor trust, states may apply one or several tests to determine resident status to the trust for income tax purposes. It is important to understand that states are not consistent in which tests, or the number of tests, it may invoke to establish income tax residency to such trust.

Let’s look at some of the various tests. These may include:

1. A trust created by the will of a decedent who was a resident or domiciled in that state;
2. An inter vivos trust (a trust created during the lifetime of an individual) created by a residing or domiciled individual in that state;
3. Determination as to which state the trust’s administration takes place;
4. The state domicile or residency of the trustees of the trust; and
5. Identification of residency or domicile of the trust’s beneficiaries.

A state such as Arizona may apply a single factor; that is, the domicile or residency of the trustees. States such as Maryland, Delaware, Idaho, and Montana may apply three or more tests.

At this point, it is very important to point out that in addition to taxing the trust based on the trust residency, states may also tax certain types of income of non-residents of their states. For example, income sourced from or within a state may be taxed by that state regardless of where an individual may reside or where a trust is located. Business income from a trade or business or rental income are types of source income that states may tax as source income.

I also want to point out that while this podcast is focusing on the state income taxation of trusts, an individual may wish to create a trust in a particular state for more than potential state income tax savings. A particular state may have specific trust administration laws or greater trust provision flexibility compared to other states’ trust laws.

Now you know a little bit more about the state income tax residency factors for irrevocable, non-grantor trusts. As more than 40 states impose state income taxes on residents, it is important to be aware that interpretation or application of the trust state income tax factors we have described may have been subject to litigation and a number of states’ tax rules have been evaluated through various court cases. As you can see, this is a complex area, therefore it is key to have knowledgeable, experienced advisors and engage in conversations as part of the decision-making process.

Thanks again for joining us today. Please contact your Wilmington Trust advisor if you have any questions about changing state residency for you and your family or to discuss how state income tax rules apply to the trusts you may be creating. We would be glad to help you. See you next time!

¹Example: North Carolina Gen. Stat. § 105-134.1(12)

²Maryland’s Administrative Release No. 37 issued by the Comptroller of Maryland citing statutory section 10-101(k)

_{This podcast is for general information only and is not intended as an offer or solicitation for the sale of any financial product, service, or other professional advice. The information in this podcast has been obtained from sources believed to be reliable, but its accuracy and completeness are not guaranteed. The opinions, estimates, and projections expressed are subject to change without notice. Diversification does not ensure a profit or guarantee against a loss. There is no assurance that any investment, financial, or estate planning strategy will be successful. Past performance cannot guarantee future results. Investing involves risk, and you may incur a profit or a loss. Investment products are not insured by the FDIC or any other governmental agency, are not deposits of or other obligations of or guaranteed by Wilmington Trust, M&T Bank, or any other bank or entity, and are subject to risks including a possible loss of the principal amount invested. Wilmington Trust Emerald Family Office & Advisory® is a registered trademark and refers to wealth planning, family office, and advisory services provided by Wilmington Trust, N.A., a member of the M&T family. Wilmington Family Office is a service mark for an offering of family office and advisory services provided by Wilmington Trust, N.A. Wilmington Trust is a registered service mark used in connection with various fiduciary and non-fiduciary services offered by certain subsidiaries of M&T Bank Corporation. Copyright 2023 M&T Bank Corporation and its subsidiaries, all rights reserved.}

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