posted: Jul. 23, 2011 @ 11:35p
It used to be that states only went after people for "back-taxes" that were celebrities/pro athletes earning millions of dollars, and claiming residency in another state. Over the last few months, I've noticed a trend on various finance/investing forums I view, that states are now going after everyone, even people with under $100k of income.
The scam is that states are being allowed access to federal IRS data, and running them against their DMV database for State ID's and Drivers licenses. If you *ever* had a DMV-issued ID from a state, they may attempt to come after you for back-taxes. State governments are cash-strapped and seriously hurting for money so this is now a big risk.
In the past, when I traveled frequently and lived in different states for a few months at a time, I would get a State ID from the DMV (while maintaining my drivers license in a 0% state income tax state), so that I could use the library, purchase firearms, and anything else that a local ID would provide.
I've come up with some counter measures to avoid getting nailed with back-taxes, and would like to hear others' thoughts.
1) Document everything, and retain documents for where you lived and what income you earned from what sources. Retain these indefinitely.
2) Research the definition of "domicile" and understand how it works. Technically, you can have multiple state residencies, but only one "domicile" at any given time. There is a 3 part test to determine transfer of domicile, to include having the specific intent of transferring domicile. Thus, you cannot be forced to change your domicile. This is critical, because a state will come after you for investment income earned, if they believe you are residing in their state when the income is earned.
3) Contribute as much as possible to tax deferred accounts. This has always been a "good" idea, but now it's important to look at creative means to increase tax-sheltered space. This includes E/I-Bonds, gold bullion (in an appropriately balanced portfolio), and annuities. Thus, you have no taxable investment income for a state you previously lived in to attempt to tax.
4) Figure out if you can "turn in" a State ID for a state you no longer want anything to do with. Perhaps with a certified letter to the DMV of that state, with the ID enclosed. The letter may state something to the effect of withdrawing any position of residency within that state, and that you are physically no longer in that state.
5) Be sure to file state taxes to a prior state, even if the AGI is $0, for one last year after you move, declaring that you are no longer residing in this state. Many states have in their paperwork a location to mark a date for when you moved in your taxes.
6) Avoid high risk states such as California and New Jersey. "High Risk" should be defined by 3 factors:
a) a high tax rate within that state (because it makes seeking back-taxes more profitable to the state, and more dangerous to you)
b) a large budget shortfall within the state (because they become more desperate to unethically attack you for money)
c) a history of this behavior (i.e. California has been notorious in doing this)
7) Consider using cash-only when visiting high-risk states like California, if it's feasible to do so without too much extra work. For example, if you're going to Cali for vacation for a few days and can use cash instead of credit, then do so. There's a possibility Cali will get more desperate and eventually try to claim that you resided in Cali based on credit-card transactions. It may sound absurd now, but in 5 years, Patriot Act 3 might give states the ability to scour CC statements for terrorist activity, or perhaps to verify sales-tax payment on internet purchases. Then the States will of course use this data for other revenue-generating purposes.