The increase in Illinois tax rates was supposed to be temporary but now it appears headed towards permanence. There are proposals to change Illinois tax rates to graduated tax rates instead of the current flat tax rate system. An additional tax on high income taxpayers has also been suggested. The effect is many people are thinking about changing their state of residence.
Illinois citizens may be new to understanding the process of changing residency. This issue was not viewed as critically by taxpayers or the Illinois Department of Revenue when the Illinois income tax rates were relatively low compared to other states. The issue is front and center in states like New York and California as these states have been aggressive for many years in protecting their revenue base when their taxpayers attempt to establish residency in another state. Residency changes have been audited and litigated extensively, and an entire body of law has developed that can be applied as Illinois citizens attempt to change their residence.
There are generally four or five factors to consider when determining if you should change your residence (domicile) for tax purposes, as summarized below. One item to note is certain income will be taxed in Illinois whether or not the recipient resides in Illinois. This includes income from real estate located in Illinois or income from a trade or business located in Illinois. Income received through flow-through entities by a non-resident also is subject to Illinois tax withholding.
Domicile Factors to Consider...If you don't, Illinois or other states will
1) Home - which house gets the title
The pattern of use of the Illinois residence is compared to the use of the non-Illinois residence. Questions about the timing of use are important. Also, community involvement and where family events are held can be considered. Yes, the place where the Thanksgiving turkey was purchased can be significant.
2) Active Business Involvement - location matters
The pattern of employment and compensation received is considered as well as active business involvement other than employment. The location of working on a daily basis and the location of the taxpayer's office are prime considerations. If the taxpayer is retired, this will not be a factor in the analysis.
3) Time - supporting evidence tells the truth
Time is typically the most important factor in a domicile case. Generally, an individual is going to spend the majority of time at "home."
Taxpayers should make sure they spend less than 183 days in Illinois, but this may not be enough under the domicile test. The case often turns to where the taxpayer spends the most time. This is generally established through a detailed review of activity for each day of an audit period. Many types of evidence are reviewed including diaries or appointment books, expense reports, credit cards, phone bills, frequent flyer statements, passports, and other similar documents.
4) Near and Dear - if it's valuable, keep it with you
This factor involves reviewing the location of those items that are of value to the taxpayer, whether because they are of significant value or just items of sentimental value. Yes, most people keep the family photo album where they reside.
5) Family - it's not just about your location
The family factor applies only to the spouse and minor children, although occasionally the location of other family members (siblings, parents, and so forth) may be determinative in a person's choice to change domiciles.
Notice we have not mentioned things like voter registration and driver's licenses because these items are not considered all that important in a residency audit. These are good to have to support the residency position, but these are not determinative.
If you are considering establishing residency in another state, please research the requirements, talk to your accountant and financial advisors to evaluate the benefits, and carefully follow the rules. If a taxpayer happens to be audited after a residency change, the process is in-depth and very thorough.
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