We continue to get questions from snowbirds and others as to how an individual can shift his or her residency to a lower or no tax state, (e.g., Florida, Nevada, or Texas), while still maintaining a home and/or other Illinois connections. As background, the Illinois individual income tax rate decreased on January 1, 2015, from 5 percent to 3.75 percent, while the corporate income tax rate decreased from 7 percent to 5.25 percent (the additional 2.5 percent replacement tax did not change). However, in light of Illinois’ current economic state and future debt obligations, it is hard for many Illinois residents and businesses not to be skeptical that the lower tax rates will stick. Many people are also concerned that Illinois could try to change the income tax base, such as disallowing existing deductions for pension income. Any changes to the existing rate, however, would have to be evaluated in light of Illinois’ constitutional limitations that prohibit a graduated tax rate scheme and limit the corporate-to-individual tax rate to no more than an eight-to-five ratio.
Changing one’s state tax residency can be very challenging, especially for a snowbird. The residency rules vary from state to state and can change over time. In fact, changing residency is not simply a matter of purchasing a vacation home or spending the winter in another state. In Illinois, a resident includes an “individual who is in Illinois for other than a temporary or transitory purpose during the taxable year.” A person is also considered a resident if Illinois is that person’s “true, fixed, permanent home and principal establishment, the place to which he or she intends to return whenever absent.” Illinois administrative guidance tells us that a rebuttable presumption of residency exists if an individual 1) receives a homestead exemption for Illinois property tax or; 2) is present in Illinois more days than he or she is present in any other state if that person was an Illinois resident in the prior year. In a case decided in 2013 (Sweeney v. State of Illinois), an individual was able to overcome the Illinois Department of Revenue’s assertion of Illinois residency by showing that the individual had abandoned his Illinois residency through his physical presence in and intention of making Florida his new residency. The types of evidence used to support his case included utility bills, bank statements, registration and maintenance of a vehicle, a five-year fishing license, a yacht club membership, and an address used for mail. Note that laws addressing residency for individual tax purposes are different from laws for non-tax issues, such as Chicago’s residency rules related to running for political office (for example, Rahm Emanuel’s Illinois Supreme Court case on eligibility for mayor).
Illinois will consider a typical snowbird as an Illinois resident if he or she is an individual who stays at his or her Florida home during the winter months; maintains an Illinois home; physically spends more time in Illinois than outside of Illinois; and whose voter registration, driver’s license, bank accounts, and club memberships are all in Illinois. Alternatively, an individual who sells his or her Illinois business and Illinois house and subsequently moves to his or her Florida home with the intention of making that new location his or her permanent home will have a better position to prove that his or her tax residency has changed.
An Illinois resident is also defined to include certain estates or trusts whose decedents were domiciled in Illinois, as well as irrevocable trusts with grantors who were domiciled in Illinois at the time the trust became irrevocable. For this reason, it can be difficult to change a trust’s or estate’s residency to a different state, although with advanced planning, it may be feasible. However, taxpayers need to be thoughtful as the worst possible outcome would be having more than one taxing state claim that an individual is a resident at the time of their death.
While the tax rate is a very important component, there are other income tax considerations that should be factored in when assessing an individual’s income tax obligation, especially for multistate business owners. For example, in many states, a resident generally pays tax on 100 percent of his or her federal taxable income, as adjusted, for differences between state and federal tax laws, and receives a credit for certain taxes paid to other states as a nonresident individual. Thus, the types of income a state taxes — such as retirement income, deferred compensation, and stock options — and the application of the credit for taxes paid to other states is very important in assessing a change in tax residency. For example, Illinois does not tax many types of retirement income, regardless of where it was earned, but Illinois’ other deductions and credits for taxes paid to other states are not as broad as some other states.
Owners of businesses conducted through a partnership or an S corporation face an additional layer of complexity in that such income is generally not allocated to the state of residency, but rather is sourced according to the given state’s specific rules for apportioning business income. Many states apportion income based on the amount of revenue earned within a state relative to revenue earned in all states, thereby often limiting the option to move business income to another state to realize tax benefits. For example, if you own an interest in an S corporation that earns income in Illinois, you will still pay Illinois tax on this S corporation’s Illinois income, even if you are able to establish residency in Florida.
Illinois is certainly not alone in its pursuit of additional funding, and, as a result, individuals and businesses will naturally look at their options. However, while it may be tempting to think about changing one’s tax residency to a lower-taxing state, non-tax factors usually trump taxes. For example, many individuals would never consider moving from Illinois because of their family and close friends, and their loyalty to their communities and the state. These Illinois residents may also own Illinois businesses that require them to be physically present. In the real world, if tax rates were the only issue, few would live in California or New York, which have top individual tax rates of 13.3 percent and 8.82 percent, respectively. Individuals who can and do consider changing their residency should carefully consider the personal and tax consequences of their decisions. With careful planning, some Illinois residents can reduce their state tax burden if their personal and business life affords them the flexibility to actually change their residency to a state with lower or no income tax.