Take-Away: If an individual is a resident of one of the 43 states that imposes a state income tax, like Michigan, the state income tax may be imposed on all of the individual’s income, even income that is earned outside his/her state of residence. Nonresidents of these 43 states may only be taxed on income that is earned within the state. Consequently, the concept of an individual’s residence is of critical importance to assess state income taxes, or in some cases for states that impose state estate or inheritance taxes.

Background: While most states assess income taxes on the basis of an individual’s residence, most of their tax statutes actually refer to the legal concept of domicile. Residency and domicile are not interchangeable legal concepts, although we tend to use the terms that way. Domicile requires some expectation of permanency while residence is simply where one is at, at that point in time.

Resident: Michigan’s definition of a resident for purposes of imposing Michigan’s income tax effectively relies on the individual’s domicile. That statutory definition follows:

“Resident is an individual domiciled in the state. Domicile means a place where a person has his true, fixed and permanent home and principal establishment to which, whenever absent therefrom, he intends to return, and domicile continues until another permanent establishment is established. If an individual during the taxable year being a resident becomes a nonresident, or vice versa, taxable income shall be determined separately for income in each status. If an individual lives in this state at least 183 days during the tax year or more than ½ the days during a taxable year of less than 12 months he shall be deemed a resident individual domiciled in this state.” [MCL 206.18.]

Change in Residence: Once domicile is established in Michigan, an individual’s domicile can only change when three (3) separate criteria are met:

#1. Intent to Abandon Michigan: The individual has a specific intent to abandon his/her old [Michigan] domicile, which can be demonstrated by: (i) employment is transferred to another state; (ii) relinquishing a Michigan voter’s registration or driver’s license; (iii) registering the individual’s motor vehicle in a new state; and (iv) relinquishing Michigan real property, or demonstrating the intent to relinquish Michigan real property.

#2. Intent to Acquire New Domicile: The individual has a specific intent to acquire a new domicile, which can be demonstrated by: (i) obtain (rent or purchase) real estate   out-of-state; (ii) make a formal declaration of domicile in another state; (iii) obtain a driver’s license in another state; and (iv) file a tax return in another state.

#3. Physically Live In Another State: The individual physically lives in a new domicile, which can be demonstrated by: (i) the individual, their spouse, and their dependents actually move to a new state from Michigan, or by providing a good explanation why the individual’s spouse and/or dependents did not move with the individual out of Michigan; (ii) the location of the individual’s checking or savings account is now in the other state; and (iii) the location of organizations the individual is involved with are in the other state, e.g. church membership; service club membership etc. [ Source: Michigan Department of Treasury, Form 3799.]

Residency in the Courts: Only a couple of Michigan court cases have addressed an individual’s residence within the state, and neither is very helpful to determine if an individual continues as a Michigan resident for Michigan income tax assessment purposes.

  • Said v Department of Treasury, 628 N.W. 2d 100 (Michigan Court of Appeals, 2001): In this decision, the Court found no presumption of Michigan residency despite the individual filing a federal income tax return that used a Michigan PO mailing address. The individual moved to the U.S. from Yemen in 1939. Yet his wife, children, and his important possessions all remained in Yemen. He worked as a seaman on the Great Lakes. In 1989, he filed a federal income tax return and reported his address as a Michigan PO Box held by a friend. In 1988, he worked 231 days on board a ship, and 237 days on board a ship in 1989. The Court held that just because the seaman had become a U.S. naturalized citizen in 1973, that fact alone did not automatically require that he automatically had to become a resident of one of the 50 states. In short, the seaman did not need to abandon his domicile in Yemen in order to become a naturalized U.S. citizen and a resident of Michigan. Nor did his use of a PO mailing address in Michigan create a legal presumption of his Michigan residency. Consequently, the individual did not establish any domicile in Michigan for any income tax reporting purposes.
  • Molter v. Department of Treasury, 505 N.W. 3d 244 (Michigan Supreme Court, 1993): Molter participated in an IRC 457 deferred compensation plan while he worked as a State of Michigan employee. In 1983, one year after he retired, Mr. Molter moved to Florida. As a Florida resident, Mr. Molter claimed that the distributions that he received from his (Michigan) IRC 457 deferred compensation plan should not be subject to any Michigan income tax. Michigan continued to withhold state income taxes from Mr. Molter’s 457 distributions. Michigan withheld income tax on both the 457 distributions, and the interest income that had accrued on those 457 funds up to the date that Mr. Molter changed his domicile to Florida. Mr. Molter challenged Michigan’s ability to tax both his deferred compensation distributions (that he had earned in Michigan) and the accrued interest on those accumulated 457 funds. The Court exempted from income tax the interest that was earned on the deferred compensation distributions after Mr. Molter became a resident of Florida. However, the Court held that Michigan’s taxation of Mr. Molter’s deferred compensation, and any interest that accrued on those distributions earned while Mr. Molter was a Michigan resident, could be taxed by Michigan.

Law Changes: The outcome in the Motler decision would be different today due to law changes at both the state and federal levels.

  • Federal: In 1996, P.L. 104-95 added Section 114 to Title 4 of the Tax Code. That Section prohibits state taxation of identified retirement income of nonresidents received after December 31, 1995. Under Section 114 retirement income means any income from (i) a qualified trust under Section 401(a) of the Tax Code that is exempt under Section 501(a) from taxation, which would be most qualified plans like 401(k) accounts; (ii) SIMPLE IRAs under IRC 408(k); (iii) an annuity plan or contract under IRC 403(a) or (b); (iv) IRC 457 deferred compensation plans; and (v) any retirement plan, program, or arrangement that is part of a series of substantially equal payments made at least annually. [Other statutory exclusions have not been identified in this summary.] Accordingly, this federal statute prohibits state income taxation of a nonresidents’ IRC 401(k), IRC 403(b), and IRC 457 nonqualified deferred compensation plan distributions.
  • Michigan: Effective January 1, 2012, Michigan changed the income taxation of pension and retirement benefits. These retirement benefits are now subject to Michigan income tax for most Michigan residents. The exceptions to Michigan’s income tax on retirement distributions include: (i) Military pensions, Social Security and Railroad Retirement benefits; and (ii) rollovers not included in the taxpayer’s reported federal adjusted gross income. In addition, an exemption from taxation for retirement income applies based on the year of the taxpayer’s birth and whether the individual files as a single, or married/jointly, taxpayer, which exemption can range from $20,000 to $98,054 a year.

Checklist: A following missive will list some of the steps an individual will need to take if they intend to change their tax domicile from Michigan, i.e. a change in domicile, and avoid continuing to have to pay Michigan income tax.