Ep 72:Living Abroad Won't Shake Your State Tax Shadow
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This conversation delves into the complexities of state tax obligations for U.S. citizens and green card holders living abroad.
It highlights the common misconceptions about tax liabilities when moving overseas, emphasizing the importance of understanding state-specific rules and planning ahead to avoid unexpected tax bills.
The discussion also covers strategies for cutting ties with states that impose income taxes and the significance of domicile in tax planning, particularly concerning estate taxes.
Key Takeaways
Some states don't let go of tax obligations easily.
Your relationship with your current state affects tax responsibilities.
States look at ties like driver's licenses and voter registrations. California and New York are known for aggressive tax policies.
Double taxation can occur if state taxes are not managed properly.
Establishing residency in a no-income-tax state can be beneficial.
Domicile is different from tax residency and affects estate taxes.
Working with a tax professional is crucial for compliance. Failing to meet state tax obligations can result in penalties and interest.
Chapters
00:00 Understanding State Tax Obligations for Expats
12:59 Strategies to Cut State Ties Before Moving Abroad
17:04 Navigating Domicile and Estate Taxes
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Jane Mepham, CFP (00:04)
If you moved overseas tomorrow, do you think your state would stop taxing you? A lot of people assume the answer is yes, but in reality, some states don't let go that easily. You could be living abroad for years and years and still have tax obligations back home.
Manasa Nadig, EA (00:25)
Exactly. And that's what we're going to dive into today. What do you still or when do you still have to file a state tax return? What triggers it and how you can avoid unexpected tax bills from a state while living overseas.
Jane Mepham, CFP (00:47)
Hey everyone. Welcome back. Today, we're talking about state taxes for U.S. citizens and green card holders, basically U.S. tax residents while living abroad. And what we find is that this is one of the most misunderstood areas of expert taxes.
Most people know they still have to file a federal tax return, but tax returns can get a little confusing. So before you even move overseas, you need a plan. This is one of the things we really talk about that if you're planning on moving, don't call me today and say, Jane, I'm out of here tomorrow or Manasa.
You really want to plan it out. Your relation, I know, cause you've seen some of those, right? So your relationship with your current state plays a huge role, whether they'll continue to tax you or not.
Manasa Nadig, EA (01:26)
Yeah.
Jane Mepham, CFP (01:43)
And what happens is states will look at your ties, things like your driver's license, your voter registration, your mailing address, and even where your bank accounts are located. So as you're planning and thinking about that account you left in this state, and now you're living in another state, you really want to watch out for things like that. So if these things that we're calling ties are still active, the state may make a very convincing case that you're still a resident for tax purposes and so they'll want to tax you.
And we know some states are especially aggressive about this. California is probably the most well-known, but so are other states like New Mexico, New York, South Carolina, and Virginia. They do make it difficult to sever a residency.
If you leave but keep strong connections like your license or active accounts or your voting from overseas, so your voter registration, you may still be required to report all of your income to that state, even if you aren't abroad.
Manasa Nadig, EA (02:58)
Yes. And that's where things can get expensive, you know, because unlike your federal return, most states do not follow a tax treaty. Therefore, they do not offer a foreign tax credit for taxes that you have paid in another country.
So if you're paying taxes in another country, the state that you're attached to may still tax that same income without giving you a break or without giving you a credit for the taxes you have paid to the other country, remember, because that's only at the federal level.
And that creates a real risk of double taxation. So when you think of California or New York with high income tax rates, you are looking at paying taxes on the same income.
Now, some states, though, follow a day count rule. So often around 183 days or so. And if you spend less than 183 days of time in that state, they may only tax the income that is sourced to that state.
And in those cases, you have opportunities for planning. Or there are some states where you have a rental property and then those states will tax you only on the source from that rental property and you don't have to worry about paying taxes on income from other sources like the other country where you live in right now.
So you may or may not have state-based income in this regard and then you don't have to file a return but You need to know, and that's where it's important that you need to know what that state obligation is for you.
This does not change your federal obligation. Remember, if you are a U.S. citizen or a green card holder, you file your worldwide income on your US tax return. So no matter where you live, right, you still do not get to plan around that.
It's the state taxes, of course, that we are talking about today.
Jane Mepham, CFP (05:28)
Right. And so you've actually, I was hoping you'd mentioned that. So you've mentioned it. won't go into it, the citizenship-based taxation and the worldwide US-based taxation.
So then let's go back to the question of what you can do to reduce or avoid state taxes while living abroad? One of the most effective strategies, and this is where we now talk about planning being so key before you leave the country.
Manasa Nadig, EA (05:38)
Mm-hmm.
Jane Mepham, CFP (05:56)
It is to establish residency in a state with no income tax before you leave the U.S. So, for example, states like Alaska, let's see, Florida, Texas, Washington, although I know Washington just changed something there in the last year. These states don't have state income tax.
This also, let's see, Tennessee, New Hampshire, because the only certain types of income like interest and dividend. I'm not saying you have to physically leave there, but you do need to show that somehow your ties to that state are really, really strong.
So examples are, let's say you update your driver's license, you go ahead and do your voter registration there, your mailing address there. And so basically what you're doing
You are creating a very clear documented process in that state. States look at your actions, not just your intent. So if you do that, you do have the opportunity to actually avoid state taxes.
Manasa Nadig, EA (07:05)
And this is where it kind of gets a little bit of an oxymoron, right? On the one hand, you want to cut state ties in the sense that you don't want to be paying taxes to a state for sources of income, which are not from that state. But at the same time, it may be important for you to keep a U.S. footprint, you know, in the sense like what Jane was saying earlier, you may still want to vote even if you're overseas.
After all, you're a U.S. citizen. Or there may be other reasons for which you may need a U.S. address or a U.S. footprint. And that could be created by, of course, having a mailing address, a bank account, or water registration.
And like we were talking about earlier, depending on your situation, you may still need to file a non-resident state return. Now when you're looking at this and trying to plan around this, there are some states like California that do have what is called a safe harbor exception.
So you do need to stay compliant with taxes and you do need to do that so that you don't run into trouble later. And these kinds of exceptions help you in planning around that.
So let's go back to California and the safe harbor exception. So if you are still claiming California residency or for some reasons you need to have a tie with California, then you move abroad for employment.
You can stay outside of California for at least 546 consecutive days, I suppose, and you may be treated as a non-resident. But these rules are narrow and they are very state specific, in this case with California, This is very specific.
They want you to be abroad and it has to be time abroad, has to be work related and you need to have met very specific conditions and only if you qualify you can get that safe harbor exception. So maybe this is a planning opportunity with the state that you want to keep ties to. Maybe they have other exceptions where they will let you, make that election of not having to file all of your worldwide income with that state. for each state, it's different. So be cognizant of that.
Jane Mepham, CFP (10:01)
I think what I'm hearing you say without saying it is once you decide, okay, this is the state that I want to move away from or cut ties with. It's a really good idea to work with a tax professional to help you ensure you've kind of what we say, dotted all your eyes and make sure you're really taking advantage of this.
Cause what happens in a lot of these cases, you make a move and then two months down the road, you kind of mess up because you made another.
So it's best to really work with a professional on this. That's kind of what I think is the key thing.
Okay. Now, let's talk about what happens if you did not know any of this. And again, this happens all the time. You moved a few years ago, and you haven't been filing your state taxes. Obviously, this assumes you're still in a state that requires you to file, or that you've been filing.
Manasa Nadig, EA (10:35)
Mm-hmm. Mm-hmm.
Jane Mepham, CFP (10:59)
The good news is it's fixable. You can fix it. You can go back and file prior-year returns to actually get you back into compliance. The downside is that if you all the taxes, there's likely going to be penalties and interest added on top because they'll see this as you just didn't bother filing.
But I do think ignoring the issue makes it worse over time. So I think it's really better just to bite the bullet, address it sooner rather than later, and especially don't let the state contact you to see what's happening with you. That usually makes it worse.
Manasa Nadig, EA (11:42)
Yeah. So like what you're saying is don't be that ostrich, you know, the ostrich. Yeah. Yeah. So I think the big takeaway here is moving abroad doesn't automatically end your state tax obligations. And we see this a lot, right Jane?
There was this one client for whom we were battling it out with the state of Indiana because all that Indiana had was that there was a driver's license and it didn't matter that there was no Indiana state source income. It was just that they had not you know ⁓ Cut times so that happens or property taxes for example, you know, there is a home it was homesteaded
Jane Mepham, CFP (12:26)
That's nice.
Manasa Nadig, EA (12:37)
And now that person is not living there anymore. And somehow the property tax department has talked to the income tax department and you know, they're looking at that and they're like, wait a minute. You don't live here.
Your address is not the same on your federal return, but you have this homestead. So where are you really, you know, have you really cut your ties?
So those are the things that you have to remember that could tie you back to the state where maybe you don't want to be tied to that state any longer. And it's not automatic. There are some actions that you need to put into place. So this actually becomes very clear to that state that you don't live there anymore, or you do not have domicile there anymore, or you have completely ended your state tax obligations.
And in order to do this, like we always say, you need to plan ahead. You need to understand your state's rules. Yeah.
Jane Mepham, CFP (13:41)
You do. ⁓ now you just introduced a word there, domicile. So let's just address it. So we actually have a whole episode on domicile. So domicile is described by IRS as your permanent abode. This is where you're living with no intention of leaving. Like you're planning on being there permanently.
Jane Mepham, CFP (14:08)
It's not the same as your tax residency. And we see this all the time. And it really comes into play, especially with estate taxes and related matters. So you can have multiple
residences, but you can only have one domicile. Your permanent abode. And so to your point, you want to ensure you've moved, I guess, your domicile out and you want to show them.
Manasa Nadig, EA (14:13)
Yes.
Jane Mepham, CFP (14:37)
prove that, yeah, I left, let's say California, whatever the state is, and I have no intentions of coming back because this is no longer my permanent home, not temporarily permanent home, but this is no longer my permanent home. Anything else you want to add to the domicile?
Manasa Nadig, EA (14:57)
Yes, actually, because you remember earlier we were talking and you very briefly referenced the state of Washington and they recently changed their rules as far as the domicile and estates, you know, the exclusions go and the state of Washington's estate exclusion is a lot, lot, lot lower.
Jane Mepham, CFP (15:04)
Yeah.
Manasa Nadig, EA (15:23)
Than the federal, which at this point, when we are recording this podcast, is at almost $16 million, which the state of Washington is not. So in those cases where if you still have property or you have established domicile with the state of Washington, these are planning opportunities and also things that you actually must do in order.
To make sure that you don't end up paying a ton of estate taxes ⁓ to the state. And you need to put things in place. Like again, comes back to the planning aspect of this. ⁓ And of
course, things get slightly complicated. It's above your, well, I don't like to say above your pay grade, but then if you're not a professional tax professional and you're using DIY software, you know what?
I don't know, you should be talking to a cross-border person, a financial planner, a tax planner, and an attorney who can kind of walk you through all of these and make sure that you are not gonna be hit with a surprise bill from a state that you thought you had left behind, right?
Jane Mepham, CFP (16:42)
Yeah, yeah. So I think, so I think in summary, and you've made some really good points is just because you've moved abroad doesn't mean you don't have state tax obligations. You need to be active and proactive about it if you don't want to end up paying unexpected state taxes. And so the best thing is to work with somebody so they can help you cut those ties.
Jane Mepham, CFP (17:09)
And I think I'm good with that. Anything else you want to add or should we close it?
Manasa Nadig, EA (17:15)
Absolutely. We can close this very, very short and sweet episode about cutting state ties if you're moving abroad.
And if you found this episode really helpful, dear listener, please pass it on, share it with friends and family, with anybody else who you think is looking for answers on cross-border tax and financial questions, and go to our website.
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The speakers' views and opinions discussed in this episode should not be considered financial, tax, or legal advice. Consult your advisor for any legal, cross-border tax, and financial advice.