It’s Harder Than You Think.
This article was originally posted on the Hartford Business Journal website and can be viewed by clicking here.
It’s that time of year when Connecticut’s snowbirds pack up and migrate to warmer climates.
But in addition to enjoying more comfortable temperatures, many of Connecticut’s part-time residents are in search of something else: lower taxes, especially in southern states like Florida, South Carolina, Georgia and Texas.
There were 257,984 people who claimed part-year or non-resident status in the 2017 tax year, a portion of whom have homes in Connecticut and at least one other state, according to the Department of Revenue Services.
But some who thought changing their primary address to a lower-cost zip code would allow them to avoid paying Connecticut’s higher income and other taxes have received a rude awakening.
The popular narrative is that individuals who reside in Connecticut part time, but spend at least six months and a day in another state (or country), don’t have to pay taxes here.
That’s not the case. In fact, it’s not even close. For people who live in multiple states, including Connecticut, there’s a much more complicated two-tiered test the state uses to determine an individual’s and/or couple’s permanent address, or domicile.
And it’s precisely those typically high-net-worth individuals — including business owners — who are increasingly coming into the crosshairs of this and other state’s tax collectors, especially as high-tax states like Connecticut continue to lose population, putting pressure on state and local budgets, tax lawyers and accountants say.
New York and New Jersey have become the most aggressive in auditing individuals who change their domicile, but Connecticut has also ramped-up its focus on the issue, according to a former state tax commissioner and others.
Even someone who lives in another state for seven, eight or even nine months of the year can still be considered domiciled in Connecticut and forced to pay taxes here. And people who change their domicile and get audited must hand over all sorts of personal information — like credit-card receipts, bank statements and plane tickets — to prove they’ve changed their primary residency.
“We have a lot of wealthier clients who are trying to get advice on how to sever their ties to Connecticut,” said Tony Switajewski, a CPA at West Hartford-based accounting and consulting firm blumshapiro. “There is a misconception out there that if you just spend less than 183 days in Connecticut that you won’t be considered a resident in the state. But there is also a more subjective test, the domicile test, and if the state still considers you domiciled here, that you haven’t left for good, then they can still sweep you in and make you pay taxes.”
Of the dozen or so tax lawyers and accountants contacted by Hartford Business Journal all said they have seen a significant increase in calls from clients seeking advice on how to relocate out of the state and avoid paying taxes here.
That mirrors data showing Connecticut’s steady population decline in recent years.
More than 884,000 Connecticut residents moved to another state during a nine-year period starting in 2010, compared to 720,869 who moved in, for a net loss of more than 163,373 residents, according to an HBJ analysis of U.S. Census Bureau data.
Not everyone, however, is fleeing to a low-tax destination. In fact, New York and Massachusetts are among the top states where residents here are moving.
Regardless, it’s the highest-earning residents who change their tax status that Connecticut keeps close tabs on, lawyers and accountants said.
Department of Revenue Services Commissioner Scott Jackson said in the 2017 tax year, the top 100 taxpayers in the state paid $1.2 billion in taxes — a higher-than-usual number — vs. $899 million paid by all corporations.
That shows Connecticut is highly dependent on its highest earners and any changes in their tax-filing status could have a material impact on the state budget, Jackson said.
As a result, DRS keeps a close eye on the tax returns of the state’s top 100 earners; any change in their residency will usually automatically trigger an audit.
The state has seen several high-profile individuals change their residency in recent years, including billionaire and hedge-fund manager Paul Tudor Jones and former Gov. M. Jodi Rell, who both made Florida their primary homes.
Of the 548 people employed at DRS, nearly half work in the agency’s audit and compliance division, which has experienced significantly more activity in recent years.
In fiscal 2019, the agency completed 197,066 compliance activities, which includes tax-return reviews and audits, up 83 percent from fiscal 2015, according to DRS data. Of those, 33,132 cases were handled by DRS’ income-tax auditors — up 63 percent since fiscal 2015 — who work on domicile cases.
Part of the increase in compliance activities, DRS said, had to do with the state’s recent Fresh Start program, which allowed delinquent taxpayers to come forward voluntarily and get current on their tax obligations.
Jackson, who has been DRS commissioner since June 2018, said his agency isn’t really doing anything different on domicile audits than it has in the past, but it has brought on more auditors in recent years to prepare for a coming retirement wave.
However, his predecessor, Kevin Sullivan, said the agency under his watch got more aggressive in looking at people who changed their permanent home status, because he thought the incentives to flee to lower-cost states, but not fully leave Connecticut, were getting greater.
“I wouldn’t say it was a crusade of any kind, but we were training people more, particularly auditors, to look at changes in residency, particularly in cases with high-end earners, and in some cases businesses,” said Sullivan, who was tax commissioner under Gov. Dannel P. Malloy from 2011 to 2018.
Individuals can have several residencies, but only one domicile, which is where people intend to make their permanent home.
Domicile is also key to determining where an individual or business pays certain state or local taxes. Connecticut’s law gets complicated for residents who try to change their domicile, while still maintaining a home here, said Switajewski, the blumshapiro accountant.
For those who pack up and leave the state entirely, the risk of an audit diminishes, unless they return a few years later.
Ultimately, it’s up to taxpayers — not the state — to convincingly prove they’ve relocated their domicile, and individuals have to intend to leave Connecticut for good, Switajewski said.
“It can be a heavy burden to prove that,” he said.
The two-tiered test used by the state to determine an individual’s domicile has both an objective and subjective component, and requires significant paperwork and proof to pass. The law also leaves room for interpretation on the state’s part, creating gray areas that can be hard for taxpayers to discern, lawyers and accountants said.
The first test requires an individual to prove they spent 183 days or more outside Connecticut. It’s straightforward, but if you’re audited, you better have plenty of paperwork to prove your whereabouts, said John Mezzanotte, managing partner of accounting firm Marcum’s Greenwich office, who deals with high-net-worth individuals in Connecticut and New York.
In many cases, lawyers and accountants recommended clients keep a daily log of where they are, and collect plane tickets, receipts and other documents to prove each day they are outside the state.
Mezzanotte said his clients are also increasingly using mobile apps — like Monaeo and TaxBrid — that track their daily location.
The second test is the domicile test and it considers 28 factors, including things like family, business and social connections, home and other real estate holdings and personal belongings.
For example, if an individual’s Connecticut home is larger than their Florida house that could be a problem. Some accountants recommend renting out a Connecticut home to prove it’s not a permanent residency.
Where an individual locates their personal — or near and dear — items, including pets, expensive jewelry, important collections, is also significant, as are social ties, like church, country-club or gym memberships.
It can also become an issue if one spouse spends more time in Connecticut than the other, which is common for individuals with grandchildren or other family members who remain in the state.
Business ties, including whether an individual still owns and is active in a Connecticut company, are also looked at.
West Hartford lawyer Mark Shipman represents clients caught up in domicile audits. In addition to individuals, he said he’s seeing an uptick in calls from business owners trying to figure out how to relocate their companies’ domicile before they sell their business and have to pay Connecticut taxes on that transaction.
For example, he said he’s representing a $3-million company that is projecting to grow to $20 million in annual revenue in five years, when the owners plan to sell.
They’re looking for advice on how to begin the relocation process.
“I’ve seen more calls from people who want to leave the state either because they are going to sell a business, or are retiring and want to go to a tax-free state and they still have a large income that’s not generated in Connecticut but taxed in Connecticut,” he said.
Shipman said he has created a checklist for individuals looking to break their Connecticut ties.
Among the things he advises: Do most or all of your entertaining at your new state residence; register to vote and (actually vote) and register cars, boats and other vehicles in your new state, while surrendering all Connecticut ties.
It’s not clear exactly how many domicile audits DRS performs annually. In fiscal 2019, the number was a small subset (less than 1 percent) of the 33,132 compliance activities conducted by the agency’s income-tax division, DRS said.
Anecdotally, lawyers and accountants say they are seeing more domicile audits among high-net-worth individuals, and when they do arise the amount of time and money on the line is significant.
Hartford tax attorney Louis B. Schatz, chair of Shipman & Goodwin’s tax practice group, said anyone who changes their tax-residency status and gets audited should expect a process that takes anywhere from six months to two or three years — or even longer — with tens of thousands, or even hundreds of thousands of dollars or more on the line.
“It’s commonly understood that if you are a high-net-worth individual and you leave Connecticut, you should anticipate that there is a good chance you will get audited,” said Schatz, who typically has 10 to 15 residency cases pending at any one time.
Interestingly, even people who believed they changed their domicile prior to their death can be audited, as significant estate-tax revenue could be at stake, according to Lisa Staron, a trusts and estates attorney with Murtha Cullina.
Those cases are particularly hard to defend, Staron said, because the evidentiary burden always falls on the taxpayer, even when they are no longer around.
The audit process begins when an individual is notified by DRS. That may not occur until two or three years after the taxpayer claimed to have moved their primary residency because DRS likes to review several years of living patterns, Schatz said.
Taxpayers must submit detailed paperwork to prove their domicile status, including filling out the personal-life questionnaire. Once an auditor makes a final decision, an appeal can be made to DRS’ appellate division.
Schatz said most cases get settled at the audit or appellate levels, with taxpayers often agreeing to some form of cash settlement to avoid prolonged litigation in tax court. Notably, there are only a couple well-known Connecticut court cases on the domicile issue.
Some lawyers and accountants say that’s on purpose — DRS wants to avoid the court setting significant legal precedent that would establish clear parameters on what it takes to switch a domicile.
Schatz said he doesn’t necessarily buy that argument but he does agree there isn’t much clarity on the issue.
“What’s unfortunate and what makes this such a difficult area is that there is no bright-line test,” he said. “If you sell your house and move to Florida and never enter Connecticut again, you have clearly met the standard of moving out of the state. On the other hand, if you keep your Connecticut home and you come back here for 180 days a year and have not done any of the things that are required to show that the Florida home is intended to be the place that you view as your permanent home, then you clearly have not left Connecticut. It’s the gray area between those two extremes that creates the problem and that is where most of the difficult cases reside.”
Sullivan, the former DRS commissioner, said tax officials do make judgement calls, but the state also has an obligation to verify if in fact people have permanently disconnected from Connecticut.
“It’s only fair to the rest of the taxpayers here who are picking up the burden for those folks who are leaving,” Sullivan said.
Schatz said it would be helpful if lawmakers brought more clarity to the issue, but they should also focus on what’s causing more people to leave in the first place.
“I’ve been practicing tax law for close to 40 years and I am old enough to remember when Connecticut was a tax-haven state in the 1980s and early 1990s, and people would move from New York to Connecticut to avoid the state income tax,” he said. “Things have come full circle now, where because of the high taxes and business climate people are moving out of Connecticut. You hope that our political leaders understand the issues and address them and are able to turn the situation around.”