State Taxes and American Expats
As a U.S. expatriate, you may assume that you have cut ties with your U.S. home and are not obligated to file a state return alongside your federal return (as all expats still have to do). This is not always true, however. And in the case of a few states, avoiding the state tax, even after years of living abroad, may seem almost impossible. In order to escape the state tax, there are several things you must do. It’s important to complete these tasks before moving overseas.
The “Cool” Nine
Out of fifty states, there are only nine that make moving overseas and avoiding the state tax an easy task. This is due to the fact that Wyoming, Washington, Texas, South Dakota, Nevada, Florida and Alaska do not collect state income tax from their residents (and, by extension, expatriates from the state). Tennessee and New Hampshire only collect taxes on interest and dividends, so they also make life easy for expatriates.
Moving from any of these nine states is relatively easy, at least at it pertains to your federal tax return. These states allow you to move and work overseas without being taxed back home (on the state level). Because earned income is not taxed in these states, it is wise to move overseas from any of the favorable nine, whenever it is possible. Moving to one of these states before moving overseas should be considered as it will save you from having to file a state return and paying state taxes along with your federal taxes.
The 4 Unfavorable States
If your current state of residence is New Mexico, Virginia, South Carolina or Colorado, the news is not as good. The governments of these states view their taxpayers as a needed asset. They will fight to hold on to every penny of owed tax. When leaving these states, it is up to you to prove (to the satisfaction of the state), that you will not be returning. If you cannot sufficiently prove this, you will be required to file a state return alongside your federal expatriate return.
If you are planning to return to your home state at some point, you will probably not be able to prove otherwise. South Carolina and Colorado are the most diligent when it comes to finding ties that suggest future residency. You will most likely have to file a state tax return if the state government can locate any of the following ties:
Telephne and/or utility bills
In state dependents
Property mortgage or lease
State drivers license
State investments or bank accounts
If it is important to you that you are not required to file a state tax return once you move overseas, you will need to cut all ties with your U.S. state before moving. To sufficiently end your residency with any of these “stubborn four,” it is recommended to first transfer your residency to a more amenable state (preferably the Favorable Nine) before moving overseas. This transfer of residency must be thorough, however. If, for example, you still own property in one of the stubborn states, the state government will assume you are planning to return. And if you are still generating income within these states (New Mexico, Virginia, South Carolina or Colorado) you will always be required to file a state return and pay taxes on this income.
The remaining states (thirty-seven) are neither favorable or unfavorable. The majority of these state will release you from residency status if you have been gone for more than six months (though you will have to prove residency elsewhere). Proving your overseas residency should not be overly difficult, however, once you have settled in your new home.
Separating Yourself from the Burden of a State Return
When planning to move overseas, there are usually many months of planning involved. During these months, you should also be sure to prepare for your new life as it pertains to tax issues. By taking the time to plan, you can sufficiently release yourself from the burden of filing a state return. For most expats, this benefit far outweighs the difficulty of forethought and tedious planning. The “simplest” solution is to relocate to a favorable state before heading overseas. You cannot simply stopover in one of these states, however. If this is your chosen course of action, you should plan to move months, even a full year, before picking up and moving abroad. Keep in mind that leaving dependants or property in any state but the favorable nine (especially the more stubborn states) will keep you tied to that state. Without physical ties to a stubborn state, a paper trail (bills, driver’s license, etc.) will still allow the state government to claim you as a resident.
Expatriates are used to planning, and planning is also the key to minimizing your taxes as an expat. If you have not taken the proper precautions, keep in mind that you will be required to file a state return alongside your expat federal return (whether or not you think you should actually owe state taxes).
I.J. Zemelman, EA is the founder of Taxes for Expats