By Mitch Reitman
Thinking of selling your alarm business and moving to a state with lower, or no, state income tax. Be careful about how you approach this. There are circumstances, factors, and financial and life events that occur throughout the year that could become red flags that trigger state residency audits. If you are a high-net-worth or high-income earner, i.e. someone who has just sold a business, the likelihood of being audited becomes even greater.
As states seek to fill revenue gaps and recover tax revenue losses, the risk of state residency and non-residency audits continues to grow. The risk has become so great that tax experts say that if you’re a high-net-worth or high-income individual and you move or create a similar type of red flag, there is a 100 percent chance that you’ll be audited by the state. With this in mind, here are four risk factors to consider.
1. Moving to low- or no-income tax states
As people continue to flee high-tax states like New York, California, Connecticut, New Jersey and Illinois, and are moving to low- or no-income tax states like Florida, Arizona, Wyoming, Texas and the territory of Puerto Rico, high-tax states are losing a significant amount of tax revenue. Millions of dollars are at stake, and as a result, this trend is prompting states to become more aggressive with domicile, residency and non-residency audits, and they are conducting these audits with a higher level of scrutiny.
If you sell your business and move, consider the chance of a residency audit to be 100%. One tip is to minimize the number of demonstrable ties to the original state. This will show that you have indeed moved and intend to stay in the new state. In addition, save as much data about your day-to-day whereabouts as possible so that you can prove that you did indeed move and are spending the majority of your time in the new state. When it comes to audits, the taxpayer is “guilty until proven innocent” and the burden of proof is on the taxpayer.
2. Purchasing and traveling between multiple permanent abodes
Some taxpayers own multiple homes in different states and travel back and forth between them. If you fit this category your chances for a residency audit are very high.
This is where residency comes into play. In the first example, the first hurdle to clear is changing domicile, which, for high-net-worth or high-income people, will almost certainly trigger an audit. Once that audit is completed — and hopefully won! — you then need to be concerned about residency and non-residency audits, which can occur repeatedly and at any point after changing domicile.
Let’s use the example of an alarm company owner who sells and changes their domicile from New York to Florida but still owns a home in New York to which he/she frequently travels. They would need to be careful about how many days they spend in New York. If they go over 183 days, New York will consider them New York residents and will tax their income. New York may decide to audit them even if they don’t go over 183 days. As previously discussed, the taxpayer is guilty until proven innocent and must prove that they spent less than 183 days in New York. The taxpayers must always be counting days, tracking their travels and collecting data points in case they get audited. It’s much easier to start doing this as soon as possible — and to automate and digitize this activity — versus waiting to be audited
3. Moving shortly before selling a business
If you move and then sell your business shortly after it will raise a red flag, especially if you move from a high-tax state to a low- or no-tax state. The state which you left, which stands to lose out on the taxes of the sale of the business, will almost certainly audit you and ask you to prove that the move was legitimate.
One thing auditors will look for in this scenario is whether the owner is still showing involvement in the business. For example, maintaining consistent communication with new management long after the sale will be perceived as still being involved in the business. Auditors will also look to see if the owner continues to travel to and from the state in which the business was sold. Again, this highlights the importance of keeping accurate travel and location records, and having reliable data that can be used as proof in an audit.
In line with the trend of people moving to more tax-friendly states, there is also a trend of business owners relocating their businesses where property and income tax rates are low. This can also be tricky. Filing for a change of address will draw the attention of tax authorities and will (with high certainty) trigger state auditors to pursue an investigation to verify that business operations have actually changed. Don’t think that you can change the address of your California business to Nevada without actually relocating the entire business there.
4. Moving shortly before selling a large block of accounts
Similar to the previous example of selling the business, it is not uncommon for alarm company owners to move to a low- or no-tax state before selling off RMR resulting a taxable capital gain. This will create a red flag and will likely trigger an audit.
As with the other risk factors discussed, the best way to minimize risk is to establish proof and legitimacy around the move. The taxpayer needs to show that they are not trying to cheat the system. It is recommended that they create a digital record of their location data leading up to the financial event, through the financial event and well after the event. Proof is the only thing that wins audits, and reliable data provides that proof. If you are contemplating a move, discuss it with your Tax Advisor and take steps to ensure that not only is the move legitimate, it is well documented.
Mitch Reitman is the Managing Principal of Reitman Consulting Group and a member of the Electronic Security Hall of Fame. He can be reached at MReitman@Reitman.US