You might think that moving away from the U.S. lets you off the hook for U.S. state taxes. Unfortunately, that’s not always the case. Some U.S. states still want your tax dollars, even when you don’t live there anymore.
With some planning, however, you can avoid these additional U.S. taxes, even if you hail from California or Virginia, two of the toughest states when it comes to tax.
Why State Tax Matters for Expats
Most expats don’t really think about state tax. The common perception is that you only pay state taxes if you actually live there. Unfortunately, for some states this is not the case.
You may think that your old state doesn’t know or care where you live. But if you end up returning to your old home state after a couple of years abroad and start filing tax returns again, the state will see the gap. If you cannot prove that you were resident elsewhere during that time, it may require you to pay your taxes for those missing years.
The Best and the Worst U.S. States for Expats
If your home state is Texas, Florida, or Nevada, you don’t have to worry about state income tax in general. The same is true for expats originating from Alaska, South Dakota, Washington, and Wyoming.
Generally, U.S. states fall into three broad categories when it comes to state taxes for expats: the easy ones, the some-what neutral ones, and the difficult ones.
The Easy States
The easy states for expats are those that don’t have individual income tax to begin with. These include Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.
Tennessee and New Hampshire are also fairly easy, as they only collect state taxes on interest and dividends, but not on ordinary income.
The Neutral States
Most states are neither easy nor difficult. Usually, if you have been gone for a while, they stop considering you a tax resident. In some cases, you may have to prove your new place of residence and submit some paperwork, but you are unlikely to face any major hurdles.
The Difficult States
Four states are known for making it especially difficult to escape their taxation when moving abroad. These are Virginia, California, New Mexico, and South Carolina. I have also seen issues with expats from Massachusetts, Maryland, and North Carolina.
These states won’t let you go easily, even when moving abroad. They assume that you will come back—and therefore, in the meantime, you remain a tax resident. You must convince them that you do not have any intention to stay in the state. How do you show intent? By cutting ties. Otherwise you will need to continue to pay tax on your income. More on that later…
In addition, California does not allow for the FEIE (Foreign Earned Income Exclusion). On the bright side, California has a Safe Harbor Rule, which allows Californians with employment contracts abroad to be classified as non-residents for tax purposes. The employment contract must be uninterrupted for at least 546 consecutive days (one-and-a-half years). There is a limit on your investment income during the year, and also on the number of days, you can spend in California.
How to Avoid Paying State Income Tax as an Expat
Expats from the “difficult” tax states should consider moving to another state before moving abroad, ideally to one without state income tax. This is the only way to avoid taxes in your old home state.
Furthermore, you must prove to your old state that you have moved permanently to the new state. If you do have any intention of moving back to your original state, you may have a hard time proving otherwise. Also, if you plan to keep ties to your old state, such as bank accounts or a mailing address, that will make things difficult.
Changing Your Address Is Not Enough to Avoid State Tax
Moving from a difficult state to a tax-free state requires more than just changing address. These states can be really sticky.
The tax authorities will look at your intent to establish a permanent home elsewhere, with no intentions of returning. While intent is a subjective notion, you can take the right actions to show your intent.
Every U.S. state has different tax requirements.
You should sever as many ties to the state as possible and create new ones in your new state. The tax authorities look at ties such as real estate ownership, bank accounts, voter registration, driver’s license, mailing address, family members (especially dependents), and healthcare providers.
Filing State Tax Returns
When moving away from a difficult state, file a tax return for the last tax year that shows you are a part-year resident, and that you will not be a resident anymore. You may still need to file a non-resident return in following years, depending on your state and your specific tax situation. For example, if you continue to have rental property or another income source in that state, you will have to file a return. If in doubt, it is better to file a state return as a non-resident than not filing. Consult your tax advisor.
State tax can be costly, and each state has different requirements. It’s best to hire a tax professional to obtain advice for your situation.