Contracts, Signing Bonuses, and the Substantial Presence Test

Hey, Amber, what if my (athlete) client signs a contract to play in Florida starting next season and gets a signing bonus? Is that exempt from state income tax in New York or, because she signed the contract and immediately got the bonus before she relocated to Florida, is it subject to New York state income tax? And just like that, another article is born.

Situations like these arise all the time, and not just for professional athletes. In tighter job markets, recruits are often offered signing bonuses (and sometimes moving expenses^[1]) to join a firm. Sometimes construction workers temporarily relocate to jobs in other states while they are employed by the company that hired them in their home state. This article reviews some of the foundational tax concepts to consider when evaluating sourcing of income for state tax purposes. Pro Tip: Defaulting to the substantial presence test to place your client in a low- or no-income-tax state could result in a residency audit and the associated additional tax, penalties, and interest.^[2]

Tax Home

“Tax home” is not defined in the IRC. Rather, it has (like so many other terms of art) been defined and refined by the courts and explained in Revenue Rulings. One such Revenue Ruling notes “The location of a taxpayer’s ‘home,’ though noncontroversial in the ordinary case, has been a highly controversial problem in a number of litigated cases in which the taxpayer lived in one city but worked in another.”^[3] Indeed, the foundational cases that define a taxpayer’s tax home date back to the 1920s through the 1940s:^[4]

• Flowers v. CIR^[5]—This case provides a three-prong test that must be satisfied before a travel expense is considered deductible. Prong 2 states that the expense must be incurred “while away from home.”
• Bixler v. CIR^[6]—This case establishes that the tax home^[7] is generally at or “in the vicinity of” the place of business or employment.^[8]
• Barnhill et al. v. CIR^[9]—This case establishes the idea that “the action of a taxpayer in having his home, for his own convenience, at a distance from his business” is a non-deductible commuting expense, not deductible business travel.
• Brown v. CIR^[10]—This case establishes that a taxpayer can have only one principal place of business or employment even if regularly employed in two cities in which they spend a substantial amount of time.^[11]
• Coburn v. CIR^[12]—This case establishes the law surrounding temporary employment away from the tax home or regular post of duty.

In addition to the court cases, there are several Revenue Rulings that address specific situations that have been litigated, all with respect to the potential deductibility of expenses.^[13] Nevertheless, the definition of tax home as presented by the courts and in the revenue rulings provides important information when considering income sourcing and potential state income tax implications.

Substantial Presence Test

“An individual satisfies this [substantial presence] test if he or she has been present in the United States on at least 183 days during a three year period that includes the current year. For purposes of this test, each day of presence in the current year is counted as a full day. Each day of presence in the first preceding year is counted as one-third of a day and each day of presence in the second preceding year is counted as one-sixth of a day. For purposes of this paragraph, any fractional days resulting from the above calculations will not be rounded to the nearest whole number.”^[14]

Many tax professionals may default to the substantial presence test to determine where the client’s tax home is located. As they say here in New Mexico – no bueno.

The substantial presence test is used by the IRS for the purposes of distinguishing foreign-source income (which may be excludable from U.S. income tax or for which there may be a foreign tax credit available^[15]) from their U.S.-source income. It may or may not be used by the various states in which your clients work. Each state sets its own filing requirements and definitions of residency and non-residency. Many of these may include a substantial presence test, but the SPT alone may not determine residency for state income sourcing purposes or the state’s SPT could be different from that in the IRC. Often states have nexus thresholds that include amount earned, time spent in the state, and/or businesses and/or property owned/operated in the state. In other words, spending 183 days in Florida does not make a taxpayer automatically exempt from New York, California, Oregon, or even Idaho state income taxes.

Proper state income sourcing and reporting is a valuable service tax professionals provide for their clients.^[16]

Abode or Domicile?

Black’s Law Dictionary defines abode as “a home; a place of residence.” The court cases listed above and many others make clear that it is possible for taxpayers to have multiple abodes. For example, U.S. legislators often have abodes in their home state and Washington, D.C. Celebrities often have abodes in New York and California and maybe vacation homes elsewhere. And it is possible that these people, as well as professional athletes, spend significant amounts of time each year at two abodes.^[17]

Nevertheless, for the purpose of determining a taxpayer’s tax home (whether for deducting business expenses or state income sourcing), a taxpayer can have only one domicile.

According to Steven Giacona, CPA (writing for Cerity Partners), “Domicile is generally established by extrinsic evidence of intent^[18], as a person’s intent is otherwise impossible to prove. For example, a New York court stated:

“The law is well settled and well understood as to just what must be proven to establish domicile within any particular jurisdiction. While much has been written on the subject and different words and phraseology appear in court opinions, the ultimate result is always the same, i.e., domicile is residence coupled with an intention that such residence be permanent and not temporary. Both residence and intention must be present. No single factor is controlling. All of the acts, declarations and conduct of a person, the manner of living, connections, associations, and interests must be considered, and from the over-all picture, intention must be ascertained.’ (Dupuy v. Wurtz, 53 N.Y. 556; Matter of Newcomb, 192 N.Y. 238; Matter of Daggett, 255 N.Y. 243; Matter of Trowbridge, 266 N.Y. 283.)”^[19]

Typically, the courts consider items such as the following, in addition to maintaining a place of residence, to determine domicile:

• Location of immediate family
• Driver’s License
• Hunting License^[20]
• Place of Worship
• Voting Registration

Usually, a taxpayer’s domicile is also their tax home. It is possible, however, to have multiple abodes,^[21] a domicile, but no tax home. I’m looking at you, digital nomads (and independent over-the-road truckers).

One would think that flight attendants and pilots might have no tax home, but often they have a hub city where they are assigned that is considered their principal place of work. Sometimes they also maintain a domicile at that hub city, other times they commute (often via standby air travel) back to their domicile from their hub at the end of their shift. In other words, their domicile is in one city, their tax home in another.

Writing in the EisnerAmper tax blog^[22], tax writer Josh Pittleman perhaps has one of the pithiest explainers: “Your tax home is where you work. Your abode is your current home [or homes]. Your domicile is your permanent home.”

Timing Is Everything?

Is there a tax planning opportunity here? Possibly. Consider, for example, a taxpayer who lives in a low- or no-income-tax state who is offered a job and a signing bonus at a large accounting firm but who must relocate to that firm’s corporate offices in a higher tax state for the job:

• When was constructive receipt of the signing bonus?
• Where was the taxpayer’s tax home at the time?
• When did the taxpayer relocate to their new tax home?
• How is income sourced by the new state (and the old state)?

For example, let’s look at the athlete. Revenue Ruling 2004-109 discusses what comprises an athlete’s wages for purposes of FICA taxes. That Revenue Ruling references a much older Revenue Ruling that specifically stated that a signing bonus is not to be considered wages.^[23] In the situation discussed, the bonus was contingent on the player showing up for spring training. Consequently, constructive receipt would have occurred when the player was “working” in either Florida (no state income tax) or Arizona (state income tax). The money could be either Florida-source or Arizona-source. But what about the player’s domicile/tax home? The location of the team’s home games would be the tax home because it is the principal place of business/employment for the player. But is the player domiciled there? Or do they merely maintain an abode? It is going to be up to you, the tax professional, to help determine that for state tax purposes.

Let’s say the player is contracted for three years to play in Texas (no state income tax) for the Rangers. The signing bonus is contingent on showing up for spring training in Surprise, Arizona (state income tax). But the player was playing for the Anaheim Angels for 10 years prior to signing the new contract. That player went to school at USC and was drafted into the Angels’ organization directly from college. The player has a home in Southern California that he shares with his spouse and their children who all attend school in Southern California. The player intends to play his contract with the Rangers but would like to eventually return to California because he considers that his home. This player is domiciled in California with a tax home in Texas. In all likelihood, California is going to consider him a resident for tax purposes. Yikes. Nevertheless, it is possible to get a tax credit for the state income taxes paid to Arizona if the player filed a required Arizona state return and paid the taxes.

To truly optimize for taxes, the player/taxpayer would have to permanently relocate to Texas, which as discussed above, is likely to require “extrinsic evidence of intent” to relocate to Texas. Buying a home alone isn’t going to do it. Moving the spouse and kids and changing voting registration and driver’s license would be a good start. It’s also important to remember that intrinsic intent can change. The player may decide after a year or two that he loves Texas and actually doesn’t want to return to California. It’s at that point that his residency needs to be re-evaluated for state tax purposes.

California is perhaps one of the worst examples, but I use it because California, New York, and Oregon are some of the most aggressive states when it comes to residency audits for state tax purposes. They are hard to leave.

If you are working with a client on tax planning using domicile and tax home it is important to document intent of changing domiciles (or not changing domiciles) and to do good due diligence to determine where the taxpayer maintains an abode (or abodes), where the taxpayer is likely to be considered domiciled, and where (if anywhere) the taxpayer has a principal place of business or employment. Inter-state tax planning is one case where the best offense is a good defense. Be prepared to argue your case with all of the relevant (and documented) facts and circumstances.