Filing a state income tax return
When you are a resident of a U.S. state, you are generally required to file a return in that state. Because state residency rules are fairly broad, the mere fact that you are now living abroad does not necessarily mean that you automatically became a non-resident of your former state for tax purposes.
How does moving abroad affect one’s state tax filing obligations?
If an individual is a resident of a particular U.S. state and then moves abroad, he will usually be treated by the state tax authorities 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 he was a resident.
However, with respect to the remainder of the year (and subsequent years), the critical question in most states is whether the expat is still considered “domiciled” in such state under the state’s tax rules. In many states (such as California), 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.
Example – the case of Mr. Fuller
Mr. Fuller is a high-tech entrepreneur who was born and raised in California. He is married with children, owns a home in California, and he maintains a personal account at a local bank. In July of 2017, Mr. Fuller embarked on a 2-year relocation with his family to Australia to pursue new business opportunities abroad. He began renting an apartment there for this purpose. Mr. Fuller continues to own his home and maintain his bank account in California and plans to take several trips with his family to stay in their California home during each year of the relocation. Under these facts, the California state tax authorities may argue that although Mr. Fuller physically moved from California as of July 2017, he should continue to be considered a resident of California because he has maintained sufficient ties with the state.
What other state tax issues can arise for expats?
One common situation that can trigger a state filing requirement is if an individual continues to own and rent out their house back in the U.S. The receipt of rental income from within a particular state can often trigger a filing requirement regardless of whether or not an individual has broken all ties with the state.
In addition, 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.