Retiring Boomers Beware: The Taxman Cometh
Pennsylvania residents of an age commonly known as “baby boomers” are retiring and relocating to warmer and more tax-temperate climates, such as Florida. The Pennsylvania Department of Revenue is aware of this trend, and it is guarding the commonwealth’s coffers by challenging nonresidency status and certain retirement payouts. Simply put: If your client retires and moves, they will have to prove their new status.
by Vito A. Cosmo Jr., CPA, CGMA, Patrick K. Skeehan, JD, and Matthew D. Melinson, CPA Mar 2, 2020, 14:19 PM
Pennsylvania residents of an age commonly known as “baby boomers” are retiring and relocating to warmer and more tax-temperate climates, such as Florida. The Pennsylvania Department of Revenue (DOR) is aware of this trend, and it is guarding the commonwealth’s coffers by challenging nonresidency status and certain retirement payouts. Simply put: If your client retires and moves, they will have to prove their new status. This article explores concepts such as residency and domicile, and what qualifies as tax-exempt retirement income for Pennsylvania personal income tax (PIT) purposes.
Residency and Domicile
Residents of Pennsylvania are taxed on their “worldwide” income, while nonresidents are taxed on income earned in Pennsylvania.1 This is an important distinction for retirees. Unearned income – such as interest, dividends, and capital gains, which retirees have in spades – is taxable for residents but not nonresidents. With the PIT providing more than 40 percent of General Fund revenue,2 there are obvious reasons why the DOR is concerned with a resident exodus. Therefore, be assured that the DOR will review residency status and, to borrow from the film The Godfather Part III, attempt to “pull them back in” to a Pennsylvania resident classification. Additionally, the DOR may attempt to classify recently paid retirement income as severance, which is classified as taxable compensation.3
A Pennsylvania resident is defined in one of two ways: Someone who is “domiciled” in Pennsylvania, or someone who is not domiciled in Pennsylvania but has a “permanent place of abode” in the state and spends, in the aggregate, more than 183 days in the state.4
“Domicile” is that place where an individual intends to return whenever absent; that place they consider and intend to be home;5 that place where they slide their slippers under the bed.
A person can have only one domicile, but still be a resident of more than one state.6
Furthermore, “permanent place of abode” is not synonymous with domicile. While being domiciled in a state requires having a permanent place of abode, it is simply a dwelling place. Since your client may be a resident in more than one state, they can have, correspondingly, more than one permanent place of abode.
The tax mistake many former Pennsylvanians make is dual residency. They move to Florida, buy a house, register to vote there, obtain a driver’s license, join clubs there – basically making Florida their new home. They are a Florida resident, but what about Pennsylvania?
In Pennsylvania, as with other states, if a resident was domiciled here they are considered to remain domiciled here until they have effectively and affirmatively revoked their Pennsylvania domicile.7 Establishing a Florida residency alone does not satisfy this requirement. Without taking additional steps, one can be both a Florida resident and a Pennsylvania resident. The DOR does not care what an individual has done in Florida, but rather what they have done in Pennsylvania. If your client still maintains a permanent place of abode in Pennsylvania, such as a former home, that is a problem. There is nothing in the statutes requiring an individual to sell his or her old home in Pennsylvania to revoke domicile, but, practically speaking, the DOR would have the upper hand because the burden of proof is on the taxpayer to show that they have effectively and affirmatively revoked their domicile in Pennsylvania and established it in Florida.
Inform your client to document everything they stopped doing in Pennsylvania and are now doing in Florida. If your client intends Florida to be their new home, they should prove it; the law falls squarely on intent. While that is a subjective measure, there are objective representations that former Pennsylvanians can make. They can revoke and document their Pennsylvania Homestead Exclusion, and then apply for and establish a Florida Homestead Exemption. Why? Because both homestead exemption statutes are defined by “domicile.”8
Furthermore, if your client maintains a Pennsylvania dwelling, inform them to keep careful records and logs of their days spent in Pennsylvania and Florida. The more days spent in Florida the better, because if they spend more than 183 days in Pennsylvania they will be deemed a Pennsylvania resident.
A Pennsylvania resident is defined in one of two ways: Someone who is “domiciled” in Pennsylvania, or someone who is not domiciled in Pennsylvania but has a “permanent place of abode” in the state and spends, in the aggregate, more than 183 days in the state.4
“Domicile” is that place where an individual intends to return whenever absent; that place they consider and intend to be home;5 that place where they slide their slippers under the bed.
A person can have only one domicile, but still be a resident of more than one state.6
Furthermore, “permanent place of abode” is not synonymous with domicile. While being domiciled in a state requires having a permanent place of abode, it is simply a dwelling place. Since your client may be a resident in more than one state, they can have, correspondingly, more than one permanent place of abode.
The tax mistake many former Pennsylvanians make is dual residency. They move to Florida, buy a house, register to vote there, obtain a driver’s license, join clubs there – basically making Florida their new home. They are a Florida resident, but what about Pennsylvania?
In Pennsylvania, as with other states, if a resident was domiciled here they are considered to remain domiciled here until they have effectively and affirmatively revoked their Pennsylvania domicile.7 Establishing a Florida residency alone does not satisfy this requirement. Without taking additional steps, one can be both a Florida resident and a Pennsylvania resident. The DOR does not care what an individual has done in Florida, but rather what they have done in Pennsylvania. If your client still maintains a permanent place of abode in Pennsylvania, such as a former home, that is a problem. There is nothing in the statutes requiring an individual to sell his or her old home in Pennsylvania to revoke domicile, but, practically speaking, the DOR would have the upper hand because the burden of proof is on the taxpayer to show that they have effectively and affirmatively revoked their domicile in Pennsylvania and established it in Florida.
Inform your client to document everything they stopped doing in Pennsylvania and are now doing in Florida. If your client intends Florida to be their new home, they should prove it; the law falls squarely on intent. While that is a subjective measure, there are objective representations that former Pennsylvanians can make. They can revoke and document their Pennsylvania Homestead Exclusion, and then apply for and establish a Florida Homestead Exemption. Why? Because both homestead exemption statutes are defined by “domicile.”8
Furthermore, if your client maintains a Pennsylvania dwelling, inform them to keep careful records and logs of their days spent in Pennsylvania and Florida. The more days spent in Florida the better, because if they spend more than 183 days in Pennsylvania they will be deemed a Pennsylvania resident.
Retirement Income
The good news: Pennsylvania does not tax retirement income. The bad news: Many retirement plans are not drafted with Pennsylvania law in mind. Statutorily, “retirement benefits” include distributions from a plan, qualified or unqualified, that are made upon or after retirement from service after reaching a specific age or after a stated period of employment.9 The DOR, however, treats various payments as severance, which is taxable compensation.10 Therefore, expect “the taxman” to scrutinize plans that allow distribution upon termination of employment. Payments must only be available upon actual retirement, and what your client does when they retire has consequences too.
The thorniest issue may involve retirees who have effectively switched their domicile and residency to another state, such as Florida, and receive taxable severance payments that were intended to be nontaxable retirement payments. Under federal law, Congress prohibits nonresident states from taxing retirement income of residents in other states.11 While this is moot for Pennsylvania nonresidents because Pennsylvania does not tax true retirement income, there appears to be no protection for nonresidents receiving severance payments awarded for services rendered in Pennsylvania and while the employee was a Pennsylvania resident.
Pennsylvania considers these payments taxable, even though the recipient no longer has nexus with the commonwealth, and former employers are required to withhold PIT from such payments. Pennsylvania taxes the compensation earned by nonresidents working in Pennsylvania based upon the ratio of days worked in the commonwealth divided by total available days worked.12 That works well for current compensation earned, but severance payments are made after-the-fact. Therefore, what nonresident withholding percentage should be applied to these severance payments? Should it be based upon the last year of employment? What if an individual’s average nonresident withholding percentage was 10 percent in all prior years except his or her last year, which was 90 percent? Do you then take a weighted average of the former employee’s last three years? The last five years? There are no clear-cut rules, and confusion can abound for taxpayers and the DOR alike.
As boomers retire and move away, we will likely obtain more answers to these questions as controversy is expected to increase. Until then, baby boomer clients should beware: the taxman cometh.
The thorniest issue may involve retirees who have effectively switched their domicile and residency to another state, such as Florida, and receive taxable severance payments that were intended to be nontaxable retirement payments. Under federal law, Congress prohibits nonresident states from taxing retirement income of residents in other states.11 While this is moot for Pennsylvania nonresidents because Pennsylvania does not tax true retirement income, there appears to be no protection for nonresidents receiving severance payments awarded for services rendered in Pennsylvania and while the employee was a Pennsylvania resident.
Pennsylvania considers these payments taxable, even though the recipient no longer has nexus with the commonwealth, and former employers are required to withhold PIT from such payments. Pennsylvania taxes the compensation earned by nonresidents working in Pennsylvania based upon the ratio of days worked in the commonwealth divided by total available days worked.12 That works well for current compensation earned, but severance payments are made after-the-fact. Therefore, what nonresident withholding percentage should be applied to these severance payments? Should it be based upon the last year of employment? What if an individual’s average nonresident withholding percentage was 10 percent in all prior years except his or her last year, which was 90 percent? Do you then take a weighted average of the former employee’s last three years? The last five years? There are no clear-cut rules, and confusion can abound for taxpayers and the DOR alike.
As boomers retire and move away, we will likely obtain more answers to these questions as controversy is expected to increase. Until then, baby boomer clients should beware: the taxman cometh.
1 72 Pa. Stat. Sections 7302(a) and 7302(b).
2 Pa. Dept. of Revenue, The Statistical Supplement for the Pennsylvania Tax Compendium, Fiscal Year 2015-16, at 4.
3 61 Pa. Code Sections 101.1 and 101.6(a).
4 72 Pa. Stat. Section 7301(p) and 61 Pa. Code Section 101.1.
5 61 Pa. Code Section 101.1.
6 61 Pa. Code Section 101.3(d).
7 61 Pa. Code Section 101.3(b).
8 See 53 Pa. Cons. Stat. Section 8401; Fla. Stat. Sections 196.031(1)(a) and 196.012(17).
9 72 Pa. Stat. Section 7301(d).
10 61 Pa. Code Sections 101.1 and 101.6(a).
11 Pub. L. No. 104-95, 109 Stat. 979 (1996), 4 U.S.C. Section 114. “Retirement income” is strictly defined, and includes substantially equal periodic retirement payments made for either the life of the retiree, or over at least a 10-year period. 4 U.S.C. Section 114(b)(I).
12 61 Pa. Code Section 121.6; Pa. Dept. of Revenue, Pennsylvania Personal Income Tax Guide, chapter 4.
Vito A. Cosmo Jr., CPA, CGMA, is a managing director, state and local taxes, with Grant Thornton LLP in Philadelphia. He can be reached at vito.cosmo@us.gt.com.
Patrick K. Skeehan, JD, is a state and local tax senior associate with Grant Thornton. He can be reached at patrick.skeehan@us.gt.com.
Matthew D. Melinson, CPA, is a partner, state and local taxes, with Grant Thornton and a member of the Pennsylvania CPA Journal Editorial Board. He can be reached at matthew.melinson@us.gt.com.
2 Pa. Dept. of Revenue, The Statistical Supplement for the Pennsylvania Tax Compendium, Fiscal Year 2015-16, at 4.
3 61 Pa. Code Sections 101.1 and 101.6(a).
4 72 Pa. Stat. Section 7301(p) and 61 Pa. Code Section 101.1.
5 61 Pa. Code Section 101.1.
6 61 Pa. Code Section 101.3(d).
7 61 Pa. Code Section 101.3(b).
8 See 53 Pa. Cons. Stat. Section 8401; Fla. Stat. Sections 196.031(1)(a) and 196.012(17).
9 72 Pa. Stat. Section 7301(d).
10 61 Pa. Code Sections 101.1 and 101.6(a).
11 Pub. L. No. 104-95, 109 Stat. 979 (1996), 4 U.S.C. Section 114. “Retirement income” is strictly defined, and includes substantially equal periodic retirement payments made for either the life of the retiree, or over at least a 10-year period. 4 U.S.C. Section 114(b)(I).
12 61 Pa. Code Section 121.6; Pa. Dept. of Revenue, Pennsylvania Personal Income Tax Guide, chapter 4.
Vito A. Cosmo Jr., CPA, CGMA, is a managing director, state and local taxes, with Grant Thornton LLP in Philadelphia. He can be reached at vito.cosmo@us.gt.com.
Patrick K. Skeehan, JD, is a state and local tax senior associate with Grant Thornton. He can be reached at patrick.skeehan@us.gt.com.
Matthew D. Melinson, CPA, is a partner, state and local taxes, with Grant Thornton and a member of the Pennsylvania CPA Journal Editorial Board. He can be reached at matthew.melinson@us.gt.com.
