DO EXPATS NEED TO WORRY ABOUT STATE INCOME TAXES?
As with life’s more difficult questions, the answer is that it depends. Generally, states impose tax only on individuals who are residents of the state. As such, if an individual is a resident of a particular state and then moves abroad, such individual will most likely be treated as a part-year resident for the year of the move and will most likely be required to pay tax at least on the portion of income allocated to the period in which they were a resident.
The critical question then becomes whether the state will tax the remainder of the year and subsequent years even though the expat no longer lives in the state. The question is often framed as whether the expat continues to be “domiciled” in the state even though he or she no longer lives there. The answer to this question varies by state, with three general attitudes currently prevailing.
THE GOOD, THE BAD, AND THE IN-BETWEEN STATES
In the most tax-friendly states, an income tax is not imposed altogether, so expats need not worry about state income tax when moving abroad from these areas. They include Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. Residents of New Hampshire and Tennessee are also generally spared from state income tax, although they do pay tax on dividends and interest.
In the least tax-friendly states, the requirements for breaking residency are fairly strict and require not only that one move out of the state but also sever other ties they have with the state. Such ties include selling property owned in the state, closing bank accounts and even relinquishing a state-issued driver’s licenses. These states include California, New Mexico, South Carolina, and Virginia.
Most of the remaining U.S. states lie somewhere in between. In many of these states, the general rule is that if an expat has been outside of the state for a certain amount of time (e.g., 6 months) and can prove residency outside of the state, then he or she can cut tax ties with the particular state. Once non-residency is established, then income that is not sourced to that state will generally not be taxed by such state’s taxing authority. Of course, state-source income (such as the sale of real estate located in a particular state) can remain taxable even after tax residency has been broken.
INSTALLMENT SALES
An issue of particular interest to many new expats is the state income taxation of installment sales. Often, individuals may receive income from the sale of a company and such income may be paid out in installments. Meaning, a portion of their income may be placed in an escrow account and partially released each year.
In these cases, issues arise when a transaction is consummated while the individual is a resident of the state and then receives future installment payments once they are no longer a resident. In this respect, it is important to note that the tax treatment of installment sales varies from state to state and is often very different from the federal income tax treatment.
UNDERSTANDING YOUR FORMER STATE’S RULES
When you move abroad, you may continue to have a state tax filing obligation, depending on which state you lived in before your move and your intentions when you moved. Each state has its own particular rules, so it is important to understand these rules and how they apply to your particular facts.
Our experts at Expat Tax Professionals have extensive experience with state and local tax issues. We can help you determine your residency status and, if required, prepare and file your state income tax return.
