Residency Audits

While Virginia is not one of the states with the highest income tax rate, it also does not rank among the lowest. Some Virginians may hope to establish residency in a state with low or no taxes in order to reduce their tax burden. While this can be a smart tax strategy, it may also trigger a residency audit.

The Virginia Department of Taxation conducts residency audits in situations where there is some question as to whether a person is a resident of our Commonwealth.  These audits are done to ensure that residents are not dodging their responsibility to pay taxes in Virginia by claiming to live in another state. The audits can be incredibly burdensome and may result in a tax bill. If you are facing a residency audit or want to avoid an audit when switching domiciles, our Virginia tax lawyers can help.

At Poole Brooke Plumlee PC we offer smart, strategic tax law planning and representation in both state and federal tax matters. Our goal is to guide our clients through the often complicated world of tax law to help them get the best possible outcome. To learn more or to schedule a consultation with a Virginia Beach tax law attorney, contact our law firm today.

Understanding Virginia’s Residency Requirements

In Virginia, nearly all residents are responsible for filing an income tax return. Nonresidents are also required to file tax returns in the state if they receive income from Virginia sources. For state tax purposes, there are three categories of people:

1. Resident: A person who lives in Virginia or maintains a place of abode in the state for more than 183 days during the year, or a person who is a legal (domiciliary) resident of Virginia, is a resident for income tax purposes.
2. Part-Year Resident: A person who either moves to Virginia during the year with the intent of becoming a resident or a person who moves out of Virginia to become a resident of another state is a part-year resident for income taxes.
3. Nonresident: A person who does not reside in Virginia but who receives taxable income from Virginia sources is considered a nonresident.

In Virginia, there are 2 types of residents, actual and domiciliary residents.  Actual residents are people who are either physically present in the state or maintain a home here for more than 183 days during the year. A domiciliary resident is a person who maintains their legal residence in Virginia, but may or may not physically reside in the state. For example, a college student who leaves Virginia to attend school in another state may be considered a domiciliary resident.

If you are a Virginia resident, and you meet the filing thresholds, then you must file an income tax return with the Commonwealth. Even if you are living elsewhere, if your permanent, legal residency is in Virginia, then you are required to pay taxes in the state. If there is a question about your residency status and whether or not you should be paying taxes in Virginia, you may be subject to a residency audit.  Military members and their spouses often have questions concerning their residency status and liability for state taxes, and the answer is dependent on each member’s and spouse’s unique situation.

Virginia Residency Audits

The Virginia Department of Taxation may conduct a residency audit in a few different scenarios. If you live and work in the state, then the chances of a residency audit are low. However, if you work in another state or country or attempt to establish residency in another state, then Virginia may perform an audit to confirm that you have established residency in another location.

For example, there are several states, such as Florida and Texas, with no state income taxes. If a Virginia resident stops paying taxes and claims that they are a resident of one of these no or low-income tax states, it may raise some red flags. This can trigger a residency audit.

A residency audit is designed to determine if you correctly filed taxes in Virginia as a resident or part-year resident in Virginia. Because Virginia residents are subject to tax on all of their income, while nonresidents are only taxed on income attributable to Virginia, there can be a significant difference in tax liability based on your status.

These residency audits most often target high-income taxpayers claiming a move into or out of Virginia. The audits can be incredibly invasive and typically examine 3 areas:

1. Whether you are an actual or domiciliary resident of Virginia;
2. If you have otherwise established residency in Virginia; and
3. Whether you properly allocated your sourced income to Virginia if you are a nonresident.

First, the audit will determine if you are a resident of Virginia based on the standards listed above. This inquiry looks at a variety of factors including principal place of abode, voter registration, driver’s license, and the extent of your ties to any other state. While transferring IDs and registrations can be helpful, it may not be enough on its own to prove a change in domicile.

A party claiming a change in domicile has the burden to prove that they abandoned their residence in Virginia and moved to the new location with the intent to remain there permanently. The Virginia Department of Taxation will look at things such as:

• Whether you still own and maintain property in Virginia.
• If you still have a home in Virginia, is it treated as your primary residence? (I.e., Do you rent it out? Where do your kids attend school? Do you claim in-state tuition?  Do you have roots in this community or in another community?)
• Where you are employed and if you have any active business involvement in Virginia. For example, if you are a partner in a Virginia-based business and actively participate in day-to-day decision-making, that may be evidence of a Virginia domicile.
• The amount of time that you spend in Virginia compared to another state or location. You might not meet the statutory 183-day test for domicile, but the ratio of time spent in Virginia compared to a different location may show that Virginia is still your domicile. The pattern of how you spend your time may also be considered.
• Where your high-value property is located (i.e., if you keep sentimental items like family photo albums in your Virginia home, that might indicate that it is your domicile.
• Where your family (spouse and minor children) resides.

Tax auditors will also examine whether you meet the statutory residency test for Virginia. Generally, this means that you live in and/or maintain a place of abode in Virginia for 183 days or more each year. While this may seem like an easy thing to prove or disprove, it can actually be complicated. In many cases, the auditors will rely on documentation like cell phone usage, credit card and/or ATM statements, EZ-Pass records, and flight or travel records to prove that you lived in Virginia for at least 183 days.

If you can prove that you are a nonresident of Virginia, you will still have to demonstrate that you correctly allocated income from Virginia sources on an income tax return. With the exception of certain wage earning border state residents, nonresidents who receive taxable income from Virginia sources are still required to pay income tax on that amount and file a tax return in Virginia.

Income from Virginia sources means any income that is derived from labor performed, business conducted, or property held in Virginia. It also includes lottery prizes and gambling winnings from Virginia. For example, if you receive income from your ownership of a rental property or a business that is located in Virginia, you will be required to pay taxes on that income.

During a residency audit, the Virginia Department of Taxation will examine paperwork such as W-2s, employment agreements, K-1s, property records, and stock option agreements to determine what income was sourced from Virginia. The auditor will then ensure that you properly allocated that income on a Virginia income tax return. 

The residency audit process can be slow and complex.  They may also result in a tax bill if the Commonwealth of Virginia determines that you did not pay income taxes on all or part of your income based on your residency status. This tax liability may include both outstanding taxes as well as interest and penalties for failure to properly file your income taxes.

Our Virginia tax attorneys are adept at navigating residency audits and other complicated state tax law issues. We can help you gather the necessary paperwork to prove your residency status and advocate for you with the auditor. If you owe taxes to Virginia, we can help try to negotiate a settlement of that liability.

We also offer proactive legal advice for Virginians who are seeking to change their domiciles. With long experience in Virginia tax law, including representing clients in residency audits, we know what the Virginia Department of Taxation looks for when conducting an audit. Our team can offer you thoughtful, strategic counsel on how to properly establish residency in another state or location and how to allocate income from Virginia sources as a nonresident.

Representation for Virginia Residency Audits 

A residency audit can be incredibly stressful. It often requires providing documentation of things that can be hard to prove, like where you spent your days and nights a year or more ago. Our law firm can represent you in a Virginia residency audit and provide advice on how to properly change domiciles to minimize the likelihood of such an audit.

At Poole Brooke Plumlee PC we have decades of experience advising both residents and nonresidents of Virginia on state and federal tax issues. Our Virginia Beach tax attorneys will analyze your situation and help to protect your interests throughout the process. To learn more or to schedule a consultation with a Virginia tax lawyer, call our law offices at 757-499-1841 or fill out our online contact form.