7 Challenges When Changing Business State Tax Residency

Understanding State Tax Residency

State tax residency refers to the legal resident status of an individual or business entity in a certain state. Each state has its own law-defined criteria for determining residency status. Understanding them is critical to staying legal and accessing many benefits while avoiding problems like double taxation.

There are also several factors that influence tax residency status. These factors vary between individuals or businesses, but the core concepts are similar.

For Individuals

●  Domicile is the place an individual sees as their permanent home. These are places people intend to return to often, even if they are living somewhere else right now. Domicile can be established by maintaining a house, registering to vote, getting a driver’s license, and filing tax returns, among other options.

●  The place where you work or the people with whom you maintain professional bonds may influence your tax residency status. The place where your immediate family resides may also be a factor.

●  Spending time in some states can earn a state of residence. This is often earned by spending a minimum amount of time like 183 days of the tax year within the state’s borders.

For Businesses

●  A business entity is a resident of the state where it's incorporated. This functions as a state of domicile and grants the company a resident status. Be aware that this may require some proof of residence, like business licenses, tax filings, or other official records.

●  A company’s resident state might be where its main place of business is, such as its headquarters or where most of its operations occur.

●  Companies that operate outside their state of incorporation may have to register in those states or obtain a foreign qualification. Once registered, the company must follow those states’ regulations.

Differences between domicile and tax residency

Although domicile and residency are often the same, both are different concepts. While domicile is a person or company's permanent address, residency can be wherever the taxpayer spends time and performs activities. When it comes to taxation, their registered status impacts how much they’ll have to pay.

On that note, state law residency is important for taxation. Even part year residents are usually subject to state income tax on all income, regardless of its source. On the other hand, non-residents tend only to pay tax on income earned in that particular state.

7 Common Challenges in State Tax Residency Changes

Now that you understand tax residency better, it’s time to take the next step. Here are the most common challenges you can face when changing state residency for tax purposes.

1. Residency Requirements

Understand the tax rates and laws of both the current and new states. Next, follow the criteria, register, and present proof that you are a legal resident. Only then will you be able to pay your fees and file taxes to keep everything in order.

2. Tax Filing Complexities

Filing your state taxes becomes more complex after a tax residency change. That’s because you're now dealing with another set of regulations and documents. You may even have to deal with tax returns in the previous and new states for the transition year.

3. Compliance Risks

Since you’re dealing with different state taxes, the risk of failing to comply is bigger. Lack of compliance can bring undesired consequences for individuals and businesses alike.

4. Tax Planning and Optimization

You’ll want to ensure your taxes are in order. You don’t want to lose money or face punishment after changing tax residency. So, you’ll need to plan your taxes beforehand, which can be time-consuming.

5. Timing and Documentation

Timing the change in state tax residency and being up-to-date with your documentation is crucial. You must always be able to support your claim via lease agreements, vehicle registration, utility bills, etc. Be on the lookout to not miss a single deadline.

6. Residency Audits

States may conduct audits to check your claimed residency status. Individuals and companies with discrepancies between residency and reported income are targeted more often. Be ready to present documents and avoid penalties and fines.

7. Double Taxation

Failing to establish a new primary residence can lead to double taxation. In these cases, the person or business must pay taxes on their full income in both states: the previous and the new. 

Solutions and Best Practices

To ensure smooth sailing when navigating through tax residency change, you should establish a comprehensive tax residency transition plan. Using this article as a guide, you can prepare in advance and trace every step needed to optimize your transition.

We also recommend that you use the best available technologies for tax compliance and reporting. There are a number of user-friendly online tools that can help you or your business make your transition as easy as possible.

If you feel overwhelmed with all the information, consider collaborating with tax advisors and legal experts. They can analyze your case and help you with expertise and efficiency.

And never forget to adopt proactive measures to address any upcoming challenges. Leave no room for surprises.

Tax Residency FAQs

What primary factors should businesses consider when determining their state tax residency?

Incorporation, principal place of business and foreigner qualification.

What strategies or best practices can businesses employ to minimize the tax implications and risks of changing their state tax residency?

Establishing a tax residency transition plan, leveraging technology for tax compliance and reporting, using taxing advisors and legal experts, and adopting proactive measures to deal with upcoming challenges.

About Playroll

Playroll is your all-in-one global workforce management partner. Our expert team of HR professionals is ready to help you streamline your tax-related needs with our powerful SaaS solution. Don’t worry about all the legal hurdles: count on us. Request a demo today.