States are more aggressively going after the wealth of their former residents, including proceeds from stock transactions, advisors say.
“We’ve seen instances where states take some unusual positions on taxing nonresident taxpayers, with Massachusetts being a good example,” said Kateryna Melnikova, a senior manager at CBIZ MHM’s National State and Local Tax Practice in Boston. “California and New York [also] have a reputation for being aggressive when taxing nonresident taxpayers.”
In a recent New York case, she said, a nonresident was liable for state tax on stock sale proceeds because the income was ‘compensatory’ (the taxpayer acquired the stock at a value below market price in exchange for services). Similarly, in California recent cases have successfully argued that state taxes can apply to nonresident owners if the company has established a business "situs" in the state. Situs is the location in which a taxing event occurs.
“Some types of income will still attract tax from a former resident state if that income was earned during the period the person lived there,” said Marci Spivey, a CPA, tax partner and private client services leader at Cherry Bekaert Advisory in Atlanta. Examples of such income, she said, include deferred compensation and gain from the sale of stock options, as well as income from the sale of real estate and multistate business pass-through income to shareholders and owners.
In November, the Massachusetts Appellate Tax Board held in Welch v. Commissioner of Revenue that a nonresident could be taxed on the gain from the sale of stock after moving—a decision that John Pantekidis, managing partner and general counsel at wealth advisory firm TwinFocus in Boston, called an “extremely unusual and potentially overreaching decision.”
“Taxing authorities stated that these gains from the sale of the business were sourced within Massachusetts ‘if the gain is otherwise connected with the taxpayer’s conduct of a trade or business, including employment,” Pantekidis said.
Pantekidis added that New York tax authorities came to a similar conclusion in another case, “noting that despite the capital gain from an intangible resulting in capital gains, the income from the shares was nonetheless compensatory in nature and hence not from intangibles but ordinary income.”
Clients need to do their tax homework before moving from state to state and realize that states are getting smarter, too. In Welch, for instance, the Massachusetts Appellate Tax Board highlighted "that the taxpayer didn’t file in any other states while residing in Massachusetts. This aspect is being utilized by the state to assess whether all or part of the gain should be taxable,” Melnikova said.
“Understand the state income tax rules for both the former and current state, including how to establish domicile in the new state,” said Kris Yamano, a partner at Crewe Advisors in Salt Lake City. “Understand which items, including sale proceeds from a company, each state will consider taxable ... and whether any credits for taxes paid to another state may apply.”
For instance, startup companies will qualify as Sec. 1202 stock, possibly allowing taxpayers to exclude up to all of the gain of sale of this stock fro federal taxation, said Barbara Taibi, a partner for private client services at Eisner Advisory Group in Iselin, N.J.
Finally, clients should watch the timing of their relocations.
“It’s common for executives who have made significant fortunes in equity to move out of a state right before a major liquidity event to avoid capital gains,” Pantekidis said. States are getting wise to this and auditing for exactly when a former resident moved, he said.