By Vincenzo Villamena, CPA
You would think that moving away from the United States lets you off the hook from US state taxes. Unfortunately that is not always the case. Some US states still want your tax dollar, even when you live abroad.
With some advance planning however, expats can avoid state taxes.
Why state tax matters for expats
Most expats don’t really think about state tax. The common perception is that you only pay state taxes if you actually live there. Unfortunately, for some states this is not true.
You may think that your old state doesn’t know or care where you live. But if you end up returning to your old home state after a few years abroad and start filing tax returns again, they will see the gap. If you cannot prove that you were resident elsewhere during that time, they may require you to pay your taxes for those missing years.
California state tax for expats
California is one of the toughest states when it comes to tax. Not only do you have to pay state tax on your income. California does not allow for the Foreign Earned Income Exclusion (FEIE). Other states do recognize it, it is very fact dependent.
On the brighter side, California has a Safe Harbor Rule, which allows Californians with employment contracts abroad to be classified as non-residents for tax purposes. The employment contract must be uninterrupted for at least 546 consecutive days (1.5 years). In addition there is a limit on investment income during the year and the number of days you can spend in California.
California is not the only difficult U.S. state for expats.
The best and the worst US states for expats
Generally, US states fall into three broad categories when it comes to expat state taxes: the easy ones, the somewhat neutral ones, and the difficult or “sticky” ones.
The easy states
The easy states for expats are those that don’t have individual income tax to begin with. This includes Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming.
Tennessee and New Hampshire are also fairly easy as they only collect state taxes on interest and dividends but not on ordinary income.
The neutral states
Most states are neither easy nor difficult. Usually, if you have been gone for a while, they will stop considering you a tax resident. In some cases, you may have to prove your new place of residency and submit some paperwork but you are unlikely to face any hurdles.
The difficult states
Four states are known for making it especially difficult to escape their taxation when moving abroad. They are sometimes called “sticky” states and include Virginia, California, New Mexico, and South Carolina. In addition, we have also seen issues with expats from Massachusetts, Maryland, and North Carolina.
Those states won’t let you go easily, even when moving abroad. They assume that you will come back and therefore remain a tax resident for the entire time spent abroad.
To really leave the state and tax residency behind, you must show that you have no intentions to ever come back to that state. Otherwise you will need to continue to pay state tax on your income.
How expats can avoid paying state income tax
Expats from the “difficult” tax states should consider moving to another state before moving abroad, ideally to one without state income tax.
Moving from a difficult state to a tax-free state requires more than just changing your address. These difficult states can be really sticky. You must show your intent of leaving for good by cutting ties to the state.
You have to be able to prove to your old state that you moved permanently to the new state. That means if you have any intention of moving back to your state, you may have a hard time proving otherwise. Also, if you plan to keep ties to your old state, that will make it difficult.
The tax authorities will look at your intent to establish a permanent home elsewhere with no intentions of returning. While intent is a very subjective notion, you can take the right actions to show your intent.
You should sever as many ties to the state as possible and create new ties in your new state. The tax authorities look at ties such as:
- Real estate ownership
- Bank accounts
- Voter registration
- Driver’s license
- Mailing address
- Family members, especially dependents
- Health care providers
When do expats need to file a state tax return
When moving away from a sticky state you should file a tax return for the last tax year that shows you are a part-year resident and that you will not be a resident anymore. You may still need to file a non-resident return in following years, depending on your state and your specific tax situation.
For example if you continue to have rental property or some other income source in that state, you would still have to file. If in doubt, it is better to file a state return as non-resident than not filing at all.
State tax can be costly, and every state has different rules and requirements. To learn about your state and avoid potential issues schedule a free expat tax consultation.Schedule a free consultation now
A version of this post first published on International Living.