Tax Residency and Why You Should Care
Whether you are a snowbird, a digital nomad, someone who owns homes in multiple locations, or a world traveler, understanding the concept of tax residency is critical to your financial life.
What is a Tax Resident?
You pay income tax in the place where you spend the majority of your time; this is called your principal residence. To achieve residency, you have to spend a certain amount of time in a specific location each tax year. You may also need to prove that you’re closely tied to that country in some way - this is called establishing a domicile. For example, your wife and children live there, or perhaps it’s where you vote, have a driver’s license, or have registered your car. For more on how to know if you’ll owe tax – and to who – while you’re out traveling the world, read on.
Some people choose to optimize their tax residency to be in countries with no income tax or, in the US, to states with no income tax.
What are the pros and cons of being a tax resident?
The benefits and consequences of being a tax resident in location X differ from those in location Y because the rules vary so much from one place to another. Understanding the complete scope must be weighed in your decision-making process about where you seek to claim tax residency. In most cases, tax residents are subject to income tax on their worldwide income. They may also be subject to other taxes, such as capital gains tax, estate tax, and gift tax. In your quest to legally reduce your taxes, do your homework, and consult your tax professional.
What are the consequences of being a tax resident in a “no income tax” state or city?
Being a tax resident of a “no income tax” state or city sounds appealing, but it has its own complexities. In the US, there is no personal income tax in Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, and Wyoming. And residents of New Hampshire only pay tax on dividend and interest earnings, while Washington state residents are taxed on capital gains but only if they are in a high enough bracket.
Some complexities can arise, however, when the person has income or works in another US state. In these circumstances, the person may still end up filing additional US state tax returns and paying taxes in the other state.
How can I determine my tax residency?
Determining tax residency is not always straightforward. The rules for tax residency can vary by country, by state in some countries, and occasionally even by city. A typical tax standard is a 183 day test - ie. if you spend 183 days or more in a location, then you are a tax resident there. If you spend 182, you’re not.
However which countries, states and cities may claim that you owe them income tax can be influenced by a number of factors. The primary question is where you live your life. If you spend considerable time in a given location (often objectively measured using a 183 day test), and you have meaningful ties to the location, that is a great start. Often, however, you must also demonstrate that you are not also a resident (or are a non-resident) elsewhere.
What are some other easy ways for me to establish my domicile or primary residency?
Keeping track of your receipts, your calendars, your business trips and the location of your income sources is one avenue. Many people commonly pay their accountants to make sense of this data to determine residency for the year. Chrono is an app that does it automatically for you, providing an easier way to keep track of where you’ve spent your time and can help you optimize time allocation to improve your financial options.
