Change of Domicile: Saving on State Income Taxes
- Anthony J. Charles, EA
- Mar 29
- 19 min read
Military families and certain government contractors face a unique set of circumstances when it comes to state income taxes. While military service members may be exempt from paying state income tax where they are stationed, their spouse’s income can still be taxed by the state in which they are employed, unless certain steps are taken. In this article, we will explore how taxpayers, especially military families, can officially change their domicile to states with no income tax, how to win a residency audit, and how to take advantage of the Servicemember’s Civil Relief Act (SCRA) and the Military Spouse Residency Relief Act (MSRRA) for tax savings.
Defining Domicile
Before diving into strategies, it's important to understand the difference between "domicile" and "residency." Your domicile is your permanent legal home—the place you intend to return to after any temporary absences. Domicile is equivalent to state citizenship. In contrast, residency is typically determined by factors like the state in which you live or where you work, based at any given time. Despite its name, a permanent change of station (PCS) is a temporary absence from your domicile, and legally speaking, "temporary" can last years – sometimes for a whole career.
A key point for military families is that just because you are stationed in one state, you can still maintain your domicile in another state. The law allows for this because the military recognizes the transient nature of service members' assignments. For example, if a service member’s domicile is in Texas, they can still retain that domicile while being stationed in Hawaii or any other state. This is especially beneficial because Texas, like eight other states, does not have a state income tax. To make it confusing, states often use the word “residency” interchangeably with domicile. That is why state income tax returns have versions for “residents” and “nonresidents.” When used in the context of state income taxes residency = domicile.
Under the Servicemembers Civil Relief Act (SCRA), uniformed service members can maintain their original domicile, even if they are stationed in another state. When I joined the Navy, my domicile was North Carolina. The first year of my career, I had to pay North Carolina income tax on my E-1 pay. When I was assigned to a command in Jacksonville, Florida, I changed my domicile. I then paid no state income tax for the rest of my naval career, even when I was stationed in Pearl Harbor, Hawaii as an O-1E. Doing the same is highly recommended for all service members as soon as possible. This allows you to avoid paying state income taxes in the state where you are stationed, which could result in substantial savings over time. Hint: you don’t need to be stationed in a state to change your domicile to that state; it just happens to take much less work. However, any change of domicile must be made legitimately and in good faith.
One landmark case that highlights the importance of domicile is Williams v. North Carolina, 325 U.S. 226 (1945). In this case, the U.S. Supreme Court ruled that states cannot deny a person's domicile status simply because they temporarily live in another state. The case established that a person’s domicile could remain in the state of their choosing, provided there is clear intent to return. This decision is particularly important for military families, as it upholds the principle that domicile can be maintained despite PCSs, frequent or otherwise.
Change of Domicile
Acquiring a new domicile is a legal process that requires a genuine intention to make the new state your permanent home. Legally, your domicile is the place where you have your true, fixed, and permanent home and to which you intend to return whenever absent. This differs from mere residence, which can be temporary. Courts have consistently held that a change of domicile requires an intent to return there indefinitely. The legal burden of proof lies with the individual, who must provide convincing evidence of their intention to establish a new domicile. This process can be particularly important for tax purposes, as states use domicile to determine tax residency, often leading to significant tax savings when a service member or family establish a domicile in a state with no income tax.
Making a domicile change isn’t as simple as raising your right hand and declaring your allegiance to a new state. The first step is to clearly declare your new domicile, which might involve submitting a formal change of residence with military records or updating state tax documents. A critical part of this process is establishing the intent to remain in the new state indefinitely, and this can be demonstrated through actions such as registering to vote, updating your driver’s license, and filing state tax returns, if applicable. Service members should also update military records using DD Form 2058, State of Legal Residence Certificate. This form determines which state your wages are reported to and will change which state appears at the bottom of your Form W-2.
There are conflicting interpretations when it comes to whether physical presence is a strict requirement for establishing domicile. Physical presence in a new domicile is typical but not always required, but having an address in the new state provides strong evidence in your favor. Some states, however, may heavily scrutinize the absence of physical presence during domicile changes. For instance, states like California, New York, and Minnesota have high burdens of proof and often require extensive documentation and evidence of intent when physical presence is lacking. Emphasizing these nuances can help ensure compliance and mitigate the risk of legal challenges.
To survive a residency audit, it’s essential to have supporting evidence like vehicle registrations, bank accounts, and voter registration cards in your new state. A lease or deed of property ownership in a specific state helps but is not required. Having a close friend or family member with an address in a state in which you intend to change domicile would be very helpful for obtaining these documents. Please make sure you have their permission first and explain what you are trying to do. These actions and documents substantiate your claim of establishing ties to the new state and help demonstrate to potential auditors that the change is legally valid and legitimate.
You can also update your address on financial accounts, bills, and important documents to have additional evidence of intent to change. If you have business and legal documents such as articles of organization, trusts, wills, or professional licenses, you might ensure that they are established and subject to the laws of the new state. Establishing ties with social clubs, religious organizations, or other involvement in the local community of your new state also provides evidence. Think about what you would need if you moved your home permanently. Think about things that you still have that are from your old home state. Without clear evidence of intent, a state may scrutinize the validity of a domicile change and may impose taxes based on their own residency laws.
In addition to establishing a new domicile, it’s important to sever ties with the previous state. This doesn’t mean every single connection must be broken, but it does require a series of steps to show that the old state is no longer your primary residence. Key actions include notifying the previous state’s tax authority of your move and filing a final tax return. You may need to file a part-year resident or nonresident tax return with the old state. Don’t file a resident state tax return. Let your tax preparer know about your change in residency/domicile so they don’t assume that the previous year’s state tax return is the correct one this year. Other steps may involve selling or renting out any real property, changing vehicle registration, and withdrawing from local organizations such as professional associations or voting rolls in the old state. Not all steps need to be taken, and no single document or fact pattern will be dispositive. Instead, the totality of circumstances will determine if the change of domicile is genuine. By taking these actions, service members and their families can effectively demonstrate that they have legally and permanently changed their domicile, minimizing the risk of losing a residency audit and being taxed by a state they no longer consider their official home.
Residency Audits
States which derive a lot of revenue from an income tax want as many residents as possible subject to their tax laws. For state revenue departments, it’s all about bringing home the bacon for their government and keeping the tax base as wide as possible to fund whatever it wants to fund. States with high income taxes will sometimes aggressively challenge taxpayers who try to change their residency and attempt to claw back taxes from them (I am talking to you, California). This is called a residency audit. During a residency audit, the auditor will typically investigate where a taxpayer actually resides and their intent regarding domicile. However, for military families, this audit is more likely to focus on confirming whether the taxpayer maintains ties to their domiciled state rather than the traditional residency criteria, such as days spent in each state, utility bills, or property ownership, which are often impractical for service members.
Auditors may check if a military service member and their spouse are both legally domiciled in a state with no income tax, and they will look at evidence of intent. This can include voter registration, the state on your military leave and earnings statement (LES), and the state of legal residence as indicated on other official military records, even down to the detail of where your home bank is and how much activity it has.
Residency audits by high-tax states like Hawaii can be rigorous. For military families, auditors may focus on whether you have taken steps to clearly establish domicile in another state. This includes maintaining voter registration, updating driver’s licenses, and filing state tax returns in the domicile state (if applicable). States like Hawaii presume residency if you are present in the state for more than 200 days in a tax year. However, this presumption can be rebutted by showing that your domicile remains in another state, supported by documentation of your intent and actions.
Domicile Caselaw
Taxpayers may question if the strategy outlined in this article will work, and if so, what are the risks. So far, I have seen that the IRS and especially state tax authorities have a bias in favor of their institutional interests. After all, we are dealing with humans. Courts have been a mixed bag. While the government tends to win often, there are notable cases where the tax collector has been firmly put in their place. The legal determination of a person’s domicile has followed an inconsistent “we-know-it-when-we-see-it” approach. The IRS does not define the word domicile. The federal government leaves it up to the states to interpret. Changing domicile usually occurs with no issue, but when a tax collector gets fixated on a taxpayer, meticulous planning and thorough documentation is the best defense. Some states fixate on certain issues. California likes to look at the address on a taxpayer’s tax return. New York likes to see where things “near and dear” to the taxpayer are located. There are 42 states with an income tax, and each one has their own laws and regulations regarding domicile.
One of the most prominent state court cases on a taxpayer’s domicile was Mauer v. Commissioner of Revenue, 829 N.W.2d 59 (Minn. 2013), which was adjudicated by the Minnesota Supreme Court. It is a fascinating judicial opinion to read if one is on the fence about changing domicile, but don’t let it scare you. Ken Mauer was an NBA basketball referee. In the 1990s, he along with several other basketball referees got caught up in the IRS’s Operating Slam Dunk, which targeted basketball referees for abusing travel perks that came with their job. Mauer was sentenced to five months in federal prison by the U.S. District Court for the District of Minnesota for tax evasion. After his release from prison, he was confined to house arrest for five months. The day after his release, he flew down to Florida. Two days later he was in escrow on a Florida condominium, got a Florida driver's license, gave up his Minnesota driver's license, and registered to vote in Florida. Less than a week later, Mauer received advice from an accountant on changing his domicile to Florida, which included advice that Mauer maintain a detailed written log of how much time he spent in Minnesota and elsewhere. Mauer followed his accountant’s advice thoroughly. Trouble occurred when Minnesota tax authorities found out that he filed a part-year resident tax return for Minnesota that year, and the following year, he did not file any Minnesota state tax return. Minnesota conducted a residency audit after Mauer told them he was no longer a Minnesota resident, but in fact changed his residency to Florida.
The Minnesota Department of Revenue (hereinafter called the “Commissioner”) used a 26-factor test to determine Mauer’s domicile. Of course, they determined Mauer was domiciled in Minnesota for both years and taxed him accordingly. Mauer filed an administrative appeal and lost. He took the case to the Minnesota Tax Court.
Under Minnesota law, domicile means the bodily presence of an individual person in a place coupled with an intent to make such a place one's home. The domicile of any person is that place in which that person's habitation is fixed, without any present intentions of removal therefrom, and to which, whenever absent, that person intends to return.
Common law has determined that once a person has established a domicile in a state, that domicile continues until a new domicile is established, meaning a person always has one and only one domicile at a time. The Minnesota Tax Court ruled against Mauer, giving their opinion that Mauer remained a Minnesota resident during the applicable time period. Mauer appealed to the Minnesota Supreme Court. The state supreme court looked at every little detail of Mauer’s life during those two years, down to the tenth of a percent of where he spent his days. Remember, as a professional basketball referee, Mauer travelled extensively throughout the country. The justices picked apart each word that he wrote in his travel log, even zeroing in on the fact that he referred to returning “home” to his Minnesota mansion. When Mauer attempted to list his Minnesota mansion for sale with a Realtor, the supreme court took issue with the fact that he overpriced his home, didn’t place a “For Sale” sign, and did not advertise his house on the Multiple Listing Service (MLS) – they indicated that Mauer was not really making a good faith effort to remove himself from Minnesota. As a former real estate broker, I can tell you that sellers overprice their homes all the time. Even the ones who need to move out immediately. Many luxury property owners like to sell their house off market and keep “For Sale” signs out of their yard for privacy concerns. These are not abnormal actions for that type of real estate listing. Mauer even got into a heated argument with the NBA over where his “homebase” was: Florida or Minnesota. The NBA accused him of lying about his state of residence in order to inflate his travel allowance. The NBA threatened to sanction him or even fire him until he retained a travel agent to do the math and provide a report indicating that Mauer’s residence in Florida saved the NBA a few thousand dollars. The supreme court also fixated on Mauer returning to Minnesota during his travels and keeping personal property in his house (again, normal during listing periods).
The issue in these types of cases is that the taxpayer bears the burden to prove their domicile. Ultimately, the Minnesota Supreme Court ruled 5-1 that Mauer did not successfully change his domicile to Florida, despite the fact that Mauer did everything right. The Commissioner, the state tax court, and supreme court did not think his actions were enough to change his domicile. What is interesting is not that this taxpayer lost all four of his domicile determinations. What is interesting is the judicial dissenting opinion in the case offered by Justice Barry G. Anderson. It is such a striking dissent that I am including it in its entirety below:
Because I conclude that Kenneth B. Mauer properly established Florida as his state of domicile, I respectfully dissent.
I agree that the majority has correctly set out the prevailing law regarding change of domicile and also agree, as the majority states, that the burden is on the taxpayer to establish a change of domicile. In my view, the record demonstrates that he has done just that, but both the tax court and the majority here have gotten lost in the detail of the 26–factor “test” (more about that later), while ignoring major events experienced by Mauer that demonstrate that he changed his domicile.
First, it is striking that here Mauer was released from home confinement on the federal conviction on June 30, 2003, and he was on a plane to Florida the next day. Two days later, he signed a purchase agreement to buy a home in Florida and, over the next several weeks, he took actions consistent with a change of domicile—relinquishing his Minnesota homestead exemption, applying for a Florida homestead exemption, applying for a Florida driver's license, registering to vote in Florida, documenting his change of domicile with his employer in several different ways, and moving his personal belongings to his new home in Florida.
But second, and more importantly, this domicile dispute features something rarely seen in our case law: Mauer was engaged in a long-running, and noisy, argument with his employer about his decision to live in Florida. In fact, the issue escalated to threats from the NBA to fine Mauer, suspend Mauer, or even terminate Mauer's employment, yet he continued to insist that he was domiciled in Florida, not Minnesota, notwithstanding the potential employment-related consequences.
I agree with the majority that actions matter, and Mauer's actions here in moving to Florida immediately after home confinement and his willingness to do battle with his employer on the residence issue lead me to 'a definite and firm conviction that a mistake has been committed' by the tax court in rejecting Mauer's change-of-domicile claim... I would reverse the tax court for these two reasons alone.
A word needs to be said about factor W, which purports to measure residency time in both states and on which the majority relies heavily in affirming the tax court. The majority correctly reports the data, which supports the claim that a plurality of Mauer's time during the disputed tax periods was spent in Minnesota, but it does not acknowledge that Mauer has consistently said that he does not intend to reside in Florida in the summer. It is also worth noting that Mauer's unusual occupation requires extensive travel that undercuts the traditional approach of simply adding up the number of days in any one location. These unique circumstances do not invalidate factor W, and Mauer admits that this factor weighs against him. But given those unique circumstances, this factor is of limited relevance here, at least if we are serious about our oft-repeated assertion that no one factor is controlling in domicile decisions.
Finally, and more broadly and more important than Mauer's specific circumstances, a 26–factor domicile test is no test at all. It is not clear that the result here makes the problem worse for other taxpayers, but the current approach to domicile by the Commissioner is hardly 'common sense,' as the Commissioner has suggested... Taxpayers in Minnesota enter the domicile swamp at their own peril.
The Commissioner's interpretative practices as applied to the domicile rule can only be described as arbitrary. Here, the Commissioner minimizes documentary declarations of domicile, such as the address on a driver's license, because Mauer is in compliance with that factor; in other cases, the Commissioner emphasizes a failure to change a driver's license address as evidence of no change in domicile... Similarly, the Commissioner dismisses Florida homestead status as an easily met requirement. But if the taxpayer has not changed his or her homestead status, unlike here, then that failure is treated by the Commissioner as evidence of no change in domicile…
I recognize we give substantial deference to the tax court on fact-intensive issues like domiciliary status. But where, as here, the unique circumstances of Mauer's employment and his life experiences demonstrate his intent to change his domicile, I conclude that the tax court erred in rejecting Mauer's claim of Florida domicile and the tax court should be reversed.
For these reasons, I respectfully dissent.
When reading this case, I thought I was either crazy or ignorant for not understanding how the Commissioner or a court of law, a supreme court nonetheless, could rule against Mauer. He did everything I would advise a taxpayer to do when changing their domicile. Yet he lost so easily. The fact that one state supreme court justice saw an obvious change of domicile makes me feel vindicated for my opinion. The fact that five others saw the opposite says more about our tax laws regarding domicile than anything else. Domicile is a subjective question of fact, given a specific set of facts and circumstances. You can do everything correctly in tax law and yet still lose. Not just with domicile.
“Domicile in Multistate Personal Income Tax Residency Matters: Enter the Swamp at Your Own Peril” is an article by Scott R. Thomas in the Pace Law Review. In it, Thomas argues that the subjective determination of domicile by state courts is muddy at best and ridiculous at worst. It is a good article to read, as it goes over the history of domicile laws in certain high tax states. The most noteworthy case was the Newcomb case from the New York Court of Appeals in 1908 (In Re Estate of Newcomb, 84 N.E. 950). Mrs. Newcomb was domiciled in New York but moved to Louisiana at the age of 80 after establishing a school as a memorial for her daughter. She wrote the following declaration, predicting that her domicile would become a legal issue for her estate after she died:
I have now concluded to make my permanent home here, because on each succeeding day of my life now drawing to a close, I am the grateful witness of the successful development and steady growth of this noble institution [referring to the H. Sophie Newcomb Memorial College], which now engrosses my thoughts and purposes and is endeared to me by such hallowed associations. In order that there may be no occasion for misapprehension hereafter, especially in any matter touching the settlement of my estate, I desire to have it known by my particular friends that I have elected to make the city of New Orleans my place of domicile and permanent home, although of course I may occasionally visit or reside in other places.
Even though Mrs. Newcomb spent over 500 days in New York and only 150 days in Louisiana after making the above declaration, the New York court ruled in favor of Mrs. Newcomb and declared her domicile to be Louisiana. Apparently, the written declaration swayed the court in her favor. If only Mauer had the same court. The point is that it can go both ways. One of the foundational rights in the country is our right to choose where we live. If one doesn’t want to pay California income tax, then they are free to move their home to Nevada.
MSRRA and the Spouse’s Income
Congress created the Military Spouse Residency Relief Act (MSRRA) to prevent service members’ spouses from being taxed by a state where they are stationed if they are legally domiciled in another state. If the spouse is domiciled in a state with no income tax (like Texas) and works in a state that imposes an income tax, MSRRA provides them with an exemption from paying income tax to the state where they are stationed. This is crucial, as many states will attempt to tax the spouse's wages if they work there. More specifically, spouses’ employers will automatically withhold state income tax from their wages because that is just part of their onboarding procedure. I have seen a case where an employer assumed that the spouse of a service member assumed that the spouse was a resident of the state listed on the service member’s LES and withheld no state income taxes for the entire year. It turned out that the spouse was not eligible for MSRRA relief, and the military family had to pay an entire year’s worth of state income tax to the state they were stationed in. Here are the eligibility requirements for MSRRA:
Military Spouse: the taxpayer must be the spouse of a military service member on active duty.
Same Domicile: the spouse must have the same domicile as the service member.
Physical Presence: the spouse must live with the service member on military orders and not as a result of personal or independent employment decisions.
If all eligibility criteria are met for MSRRA, the temporary state cannot tax the spouse’s income, even if that income is sourced from the temporary state. Instead, the spouse’s state of domicile gains the right to tax that income. If income is withheld by the temporary state, then a nonresident state income tax return will need to be filed to claim a refund of all withheld income. That income would then need to be reported on a resident income tax return in the domiciled state, if the domiciled state has an income tax.
Let’s consider an example of a military couple. The service member is domiciled in Texas, a state with no income tax, and the spouse is domiciled in Hawaii. When the family PCSs to another state with income taxes, the spouse gets a job in the new state. Because the spouse is domiciled in Hawaii and MSRRA does not apply, the new state will tax the income based on the source of the income (the new state). However, if the spouse changes their domicile to Texas (the same as the service member), they will not have to pay state income tax to the new state. Texas, which has no income tax, would be entitled to tax the spouse’s income, but since Texas has no income tax, this results in significant savings.
When a military career ends, and the family decides to settle down, the question arises: can the domicile strategy still work? If the family buys a home and chooses to stay in the state where they were stationed, they can establish domicile there, but this may have tax implications, especially if they’re moving from a state with no income tax to one with high taxes. At that point, they may face higher state income taxes.
MSRRA Arbitrage Strategy
The MSRRA strategy can also be used even if the domicile state has an income tax. As long as the state where the taxpayer is employed (the state with the source of income) has a higher income tax rate than the domiciled state, the service member and spouse can benefit. This tax rate arbitrage allows the family to pay a lower income tax rate than they would in the state with the higher tax rate. This strategy works not only for W-2 income but also for self-employment income.
For example, let’s say the military member and spouse are domiciled in a state like Florida (no income tax) but are stationed in New York (which has a high income tax). The spouse works remotely, or perhaps in a part-time job, for a company in New York. Even though the source of the income is New York, if the spouse changes their domicile to Florida, they can avoid paying New York income tax by taking advantage of MSRRA provisions. The same would apply for self-employment income—the spouse could legally declare Florida as their domicile and avoid New York’s income taxes.
Domicile is also critical when it comes to non-source income—such as dividends, interest, cryptocurrency, and other portfolio income. Since this type of income does not have a specific state source, it is typically taxed by the state of domicile. For military families, this means that if their domicile is in a state with no income tax, all of these earnings could be exempt from state income tax, offering substantial savings.
Conclusion
Changing domicile and taking advantage of MSRRA can result in significant tax savings for military families. By establishing domicile in a state with no income tax and ensuring that the spouse changes their domicile to match the service member's, a military family can avoid paying income taxes to states with high tax rates. Understanding the residency audit process and how domicile can be used strategically for both W-2 and self-employment income is crucial. Ultimately, the strategy works even for portfolio income, making it a powerful tool for reducing tax liability over the long term. Domicile is not only important for income tax purposes but also affects other areas of law, such as the Hawaii Real Property Tax Act (HARPTA). Whether you are subject to HARPTA withholding when selling Hawaii real estate depends on your domicile, not your physical residence. This distinction underscores the importance of clearly establishing and maintaining your domicile.
