What's the difference between personal income tax residency vs domicile?

If like many Californians, you live in a different state(s) for part of the year, you need to understand the effect multiple residences has on your tax status. A lot of people choose to live in other states part-time to take advantage of lower or nonexistent state income taxes. 

We get this. This strategy can ultimately work for you, but you need to know at the onset, about the potential taxation consequences.

I want to start out by talking about the difference between residency and domicile. Residency is where one chooses to live. Domicile is more permanent and is essentially somebody's home base. Once you move into a home and take steps to establish your domicile in one state, that state becomes your tax home. 

The reality of the situation with residency is even if you go back and forth between two states, your domicile is in one of those states and one of those states has controlling jurisdiction. You cannot have a situation where you have two controlling jurisdictions. 

In a residency analysis, it is important that you stop thinking from a “where do I live?” perspective and start thinking from a tax perspective. This is where a lot of people get into trouble.

The California tax code is called the Revenue Taxation Code (hereinafter, RTC). The tax code in California imposes personal income tax on the entire taxable income of every resident in California. 

Similar to the federal model that taxes an individual’s entire worldwide income, California under RTC §17041(a) will similarly tax a resident of the state of California on all of their "worldwide income." 

In this chapter, I am going to discuss residency and domicile and how the different tax implications. If you have questions, reach out to me. My firm faces this situation with clients often and have experience addressing multi-state tax issues.

What Residency Means in California 

California, under RTC §1704(a)(2), defines a resident as, “somebody who is typically domiciled in the state or who is outside the state for either temporary or transitory purposes.” We will dive into how California defines what temporary or transitory purpose is as we get further along.

There are different concepts about residency, but the most common one stems from the individual perspective. If you pick up and leave California, move to Texas and never return to California, you have changed your residence. The problem is that most situations — whether or business-related — are not usually that cut-and-dried. 

However, if a Californian earns income in another state, they will get a credit for any taxes that they pay in that state. If you are considered a resident of California – regardless of where your income is derived from – California will seek to impose some measure of tax on you. 

The key thing to think about, is do you have a domicile in the state of California or are you only outside of California for a temporary or transitory purpose? In the minds of state policy creators, those who enjoy the protections and benefits of the state should pay taxes for the benefits and protections they enjoy.

Temporary vs. Transitory 

Under RTC § 17014(d), an individual who is domiciled in that state but who is in California or who is outside the state for less than 18 months, is somebody who California can classify as being there for a temporary or transitory purpose. 

If you are outside of California for more than 18 months for employment, then you're considered outside the state for something other than a transitory purpose. You have become a nonresident of California.

You do not gain your "freedom" immediately just by leaving the state. You have to either spend the requisite amount of time outside of California or you have to take actions that would sever your residency from the state of California, showing your intention to leave. 

You do have some grace periods to come back and visit. When you are a non-resident for this 18-month period, you can still return to California for up to 45 days, without changing your status. 

There are two exclusions to this rule:

1. If you have income from a tangible property and access to $200,000 a year, this employment-related exception to domicile does not apply. 
2. If you are leaving the state to avoid paying California taxes, there is an exclusion for that as well.

But, the more contacts you have with California, the more likely California is going to view your presence outside the state as a temporary or transient purpose. This also applies to the spouse accompanying the taxpayer.

Conclusion

The key take-aways from this chapter were to gain an understanding of residency, domicile, temporary and transitory.  It can get confusing and if you are not sure what you are doing, you can end up paying more taxes than you need to. Nobody wants that.

The state of California’s take on this is that if you are enjoying the benefits of living in the state, then you need to pay your fair share of taxes. So, if you jump from state to state frequently, your records need to reflect how long you lived in each state (including California) and why. 

If you live outside of California for part of the year, then it would be helpful to discuss your situation with me. My firm has a proven track record working with California residents who only live in the state on a part-time basis. We can help you minimize your California state tax liability and avoid a residency audit.