Michael Sardar co-wrote an article with Vishan Chaudhary for the CPA Journal titled “Claiming Residency in Puerto Rico May Spur More State-Based Tax Audits.”
In the article, Michael and Vishan discuss state-level tax audits concerning taxpayers who have claimed tax benefits under Puerto Rico’s Act 20 and 22. For context, the IRS launched a well-publicized enforcement campaign in 2021 targeting high-income taxpayers who benefited from Puerto Rico’s Act 20 and Act 22 (now technically known collectively as Act 60), but who may not have met the residency and income-sourcing requirements to claim them.
While the IRS enforcement campaign garnered a lot of media attention, taxpayers may not be aware that some U.S. states haveincreased residency audits of their own. As a result, taxpayers who claimed Act 20/22 benefits may suddenly find themselves with state residency audits.
Michael and Vishan point out that states with higher state income tax rates, such as California, New York, and New Jersey, frequently target taxpayers moving to states with low- or no income taxes, such as Florida and Nevada. “Public reporting indicates that New York State conducted 15,000 residency audits between 2013 and 2017, resulting in over $1 billion in collections and that California collected $85 million from residency audits between January and November 2023,” Michael and Vishan state.
Some higher-income tax states may expand their audit campaigns to include taxpayers claiming residency in Puerto Rico given the substantial numbers of Act 20/22 beneficiaries who move to Puerto Rico from those states. “Approximately 30% of the Act 22 beneficiaries who moved to Puerto Rico were from” California, New York, or New Jersey, the duo note in the article, citing a Congressional report on these findings.
Taxpayers must establish bona fide residency in Puerto Rico to exclude their Puerto Rico-sourced income. Puerto Rico-sourced income must not be effectively connected to a trade or business on the mainland U.S., such as a company that the taxpayer started prior to relocating to Puerto Rico. Additional tests must also be met, such as living in Puerto Rico at least 183 days of the year and not having a tax home outside of Puerto Rico.
High-tax states are now imposing, tightening, and increasing enforcement of their own state residency rules regardless of whether a taxpayer relocates or divides their time between Puerto Rico or a low-tax state. For instance, the New York Department of Taxation and Finance considers a number of factors for determining residency, including the size, value, and nature of use of the taxpayer’s N.Y. residence relative to the size, value, and nature of use of the newly acquired out-of-state residence; employment or business connections in both locations; the amount of time the taxpayer spends in both locations; the physical location of items that have significant sentimental value to the taxpayer in both locations; and the taxpayer’s close family ties in both locations.
You can learn more about state residency audits by reading the complete article here.
About Michael
Michael has extensive experience on a wide range of tax controversy and white-collar criminal defense matters, and he represents clients in all stages of civil and criminal tax controversies before the IRS, state tax authorities, the Department of Justice, and local prosecutors. Michael also represents clients in gift and estate tax audits, where he is called upon to assist taxpayers in challenging the IRS’s valuation of gifts and bequests and/or the includability of certain transfers.
About Vishan
Vishan is a paralegal at Kostelanetz LLP. He graduated summa cum laude from the University of Chicago with a degree in political science. He is a Robert Maynard Hutchins Scholar, a Gary Becker Scholar, and a member of Phi Beta Kappa.
