Income taxes and state residency

Factual Questions
1

I wonder about this every time a big lottery prizewinner is announced, and somebody hit the Powerball last week.

Income tax rates vary enormously across the U.S. Four states have no personal income tax at all. In some, the combined state and local bite can top 14%. If you learn that you are about to get your hands on a bucket of non-salary-related money (you win Lotto, your rich uncle names you his only heir, you cash out your 1989 Microsoft options), can you avoid state income tax by moving to Nevada or Florida, or some other no-tax/low-tax state?

I realize that the IRS collects federal taxes on U.S. citizens everywhere, even if they live abroad, and even if they try to become citizens of another country. But can state tax collectors reach across their borders?

I have no immediate need for this information, but I keep hoping.

2

I think the state where you were living when you won the Lotto, or cashed in the stocks would be entitled to the tax. So if you collect your lottery winnings in California today, and move to Texas tomorrow, California would still get the tax.

By the way, I’m a US citizen living in the UK, and I don’t pay US taxes. I still have to file, but since I pay UK taxes I don’t have to pay anything to the US.

3

I know that at least in Michigan, the state income tax laws allow for partial year income taxes to be paid. howeverunless you moved before the check was cut, it wouldn’t work. If you gained the income while a resident of one state, it wouldn’t necessarily matter where you moved afterward.

But, of course, should you win the big prize, I’m sure, no shortage of tax specialists and financial advisors would be beating a path to your door.

4

The nominal amount of a lotto prize is paid over a number of years and you would pay income tax as the cash came in, so it would make sense to move to a state with no income tax.

Lotto gives you the option of taking a lump sum rather than yearly payments. I do not know if you could choose the yearly payments and later get a lump sum for the rest. In this case you can move to a no tax state, get your payment and move back to your state.

In any case there are people who will buy the rights to the remaining payments (at a discount, of course) so, yes, I think you can do a pretty good job of avoiding paying taxes on that income.

IANAL and I don’t know what I am talking about. I am sure a good tax lawyer will find a way of doing this and make a tidy sum for himself in the process.

5

I’m planning to move to Washington (state). Will I have to pay California taxes on money I earn in California before I move?

6

Johnny

I went to college in California and they expected me to pay income taxes for my last partial year there.

7

I don’t know the law in every state, but I am pretty sure that in many states lottery winnings are not counted as regular earned income and are subject to different tax provisions. It may be true that a state may have no income tax but may still have a tax on lottery winnings.

8

Johny,

You will have to pay California taxes on the money you made in California. You will have to fill out state tax forms for both states plus extra forms where they figure out how much was earned in each state. At least that was how it worked in the past when I worked in two different states.

9

The general rule: For most purposes, you are taxed in each state based upon your residence (or physical presence). The state where you spend more than 180 days during the tax year (equal to the calendar year, for most people) is your permanent residence. In other states, you can be taxed based on part-year residence. You would have to file tax returns for all states where you were resident (and generating income) during the year.

If you live in one state and have income generated from another state, you could have to file a return for that other state, even if you were not physically present there.

There are also tons of exceptions; for instance, Iowa, Wisconsin, Illinois, and maybe a few others have agreements about how to treat someone who lives in one state but has income generated in the other states.

Since the lottery is paid out over many years, you would be paying tax over many years, I presume. (Sometimes, if you get a large sum of money, you are taxed on the whole sum, even if the money is paid out in installments over many years.)

The main thing, however, would be to get tax advice BEFORE you claim your winnings. For example, in some states (I think Florida was one), your winnings are paid out over 20 years. If you die after only five years, your beneficiaries do not get the remaining 15 years of payments. Thus, you want the ticket to have been bought by your ‘trust fund’ which doesn’t die but endures after your death. There are a number of similar tricks, depending on where you live and so forth, that a tax advisor and financial planner would be pleased to help you with… for a small fee. In this case, the fee would almost certainly be worth it.

I hope that this horrible problem descends on you. I’ve always thought, I’d love to have the problem of having so much earnings that I have to pay millions in taxes.

10

Johnny L.A. wrote:

gazpacho wrote:

Nope, because Washington doesn’t have a state income tax! :slight_smile:

By the way, the criterion for maintaining residence in a state can be pretty strict. The form I got from Wisconsin when I moved away from there required a lot of info. Check what the analogous form in California requires; I’m guessing you’d better be sure to be able to both prove details of living in your new state (residence, changing driver’s license, insurance, vehicle, filing new state’s tax returns, registering to vote in new state) and not living in the old (doing any buisiness or work in old state, voting, auto licence or registration, attending or having children in state schools, listing the state as residence for purposes of legal proceedings, professional licences, auto insurance, or personal will). It was also asked if you had been physically present in the state after the official departure, whether any spouse or dependent children moved with you. Also asked was if you continue to own a home in the old state. The Wisconsin form had 11 questions, with subparts going down to j. It wasn’t made clear what responses would satisfy the requirements of non-residency. I suspect that states will generally take any excuse to claim you are technically still resident.