Tax can be a subject that clients (and practitioners) dread more than any other, and one thing that is often overlooked is state taxes. Payment of state income taxes can be complex for many people, but it can be even more complex for military families. To address this, states have passed the Military Spouses Residence Relief Act (“MSRRA”). This article will briefly (and broadly) explain the issues the Act was designed to resolve, explain its applicability, and discuss some issues that may cause other problems.
State Taxes Generally
State taxes, in states that impose them, often function very similarly to federal income tax law; indeed, the District of Columbia simply uses (for the most part) the federal Internal Revenue Code. The most important similarity, for this article, is the concept of taxation of worldwide income.
A US citizen or permanent resident is generally taxed on worldwide income (if you make money abroad, it is subject to US income tax). Similarly, a state will generally tax its residents on income earned both in and out of the state.
When a state determines its residents, there are generally two tests: domicile and statutory resident. A person’s domicile is defined as a person’s true hom.. A statutory resident is generally someone who is in the state for a certain period of time (generally about half of the year).
The result of that is that a person can end up having two tax residents, which can lead to difficulties; for example, as stated above, that could mean that a taxpayer has to pay taxes on worldwide income in two different states. While state double taxation may be limited with credits, it can still be an administrative problem. Some states may require that both spouses file a joint return and that both spouses file as residents (even if both spouses are not residents). This can lead to significant difficulties when filing returns; the clients may have to file a pro forma return for one state (because the state return comes from the federal return), and then prepare one additional return for the real return.
Example: X is a resident of New York and Y is a resident of California, and X and Y filed “married filing jointly” on their federal return. For New York, X and Y can either both file married filing separate or they can file jointly, only if Y claims to be a New York resident.
Servicemember Civil Relief Act
Although there have been multiple federal laws passed to protect service members from state laws, beginning after the Civil War, the Servicemember Civil Relief Act, passed in 2003, reflects one of the most recent attempts to modernize and standardize these laws. For this article, the most important purpose of the act was contained in Section 511, which states that the domicile of a servicemember shall not change simply by virtue of the servicemember being located in another state because of military orders; instead, the “home state” of the servicemember remains the resident state of the servicemember. However, the act specifically stated that it does not apply to the servicemember’s spouse.
To illustrate, A is a domiciliary of California and S is a domiciliary of Alabama. A is assigned to duty in New York, and S accompanies A in New York, where they live for an entire taxable year. A remains a resident of California, but S is a resident of Alabama (because S did not leave Alabama with the intention to permanently relocate) and is also a resident of New York (because A and S have a permanent place of abode in New York and S was present in New York for more than 184 days).
To address the above issues Congress passed (and President Obama signed) the MSRRA in 2009. The MSRRA ensured that a military spouse would be considered a resident of his/her home state if the following conditions were met:
- The spouse must live in a state other than her own state;
- The only reason the spouse is in the nonresident state is to live with the servicemember;
- The service member is in the nonresident state to comply with orders from the military; and
- Both the service member and the spouse are able to claim the same domicile.
If a military couple can meet these provisions, then it can greatly simplify payment and filing of state income taxes, but it can also be easy to make a mistake and create difficulties.
The first requirement, while part of the test, seems trivial; if a spouse already lives in her home state, there is no need to benefit from the law.
The second prong is also crucial, but it seems like there could be some unnecessary questions about intent (if a spouse follows a servicemember to live in a state, but there are other incidental benefits, like living closer to family, the MSRRA might not be strictly satisfied [although it seems unlikely that state revenue agencies would spend a lot of time litigating on such a point]).
Living in the nonresident state to comply with military orders is an easy element to prove; a military order is exactly what it says.
Being able to claim the same domicile may be the most complex part of the test. If two spouses don’t share the same domicile, then living together in a new state, even if it’s because of military orders, will not enable the spouse to gain the benefit of the MSRRA.
Scenario 1: S is a domiciliary of California and A is a domiciliary of New Mexico. S and A marry and S is assigned to New York; A follows S to New York. Since S and A cannot claim the same domicile, S is liable to California as a resident and A is liable to New Mexico as a resident and also New York as a resident.
In the above scenario, S will remain liable to New Mexico and New York until there is a new assignment for the servicemember, or until A can establish domicile as a California resident. However, even if A can move to California, it may be very difficult to prove A is a domiciliary of California. How could A prove that A intended to establish domicile in California while knowing that A’s spouse lived in another state? Although it is possible, it seems like proving so would present an uphill challenge.
One thing to consider is that, even if all of the elements of the MSRRA are met, a military spouse may not be totally immune from tax liability in the nonresident state. All that the MSRRA state would do is prohibit the nonresident state from taxing the spouse as a resident. If A earns income from a job performed in the nonresident state, the nonresident state will still tax A on that income (because states generally tax all income generated from sources within the state).
Another thing to consider is that the MSRRA might not actually provide a tax benefit for the spouse (or the family). Not all states tax income, and if the domicile of the spouse and the servicemember taxes income, but the nonresident state does not, the two could remain taxed on income which would otherwise not be. This could be an instance where stating that there is an additional purpose to moving to the nonresident state, aside from residing with the spousal servicemember, could prove to be a benefit. For instance, if the servicemember is assigned to Florida (which is a state that does not tax income), the spouse could argue that the MSRRA does not apply because, in addition to wanting to accompany the servicemember, the spouse also wanted to permanently relocate to Florida so that she could be closer to family (thus, establishing domicile in Florida and avoiding income tax on the spouse’s home state).
Knowledge of the MSRRA may not end up saving clients substantial amounts of money and it may not necessarily prove useful for tax planning, because changing domicile is difficult and may not be financially viable, even if there is a net benefit. However, providing added services is usually appreciated, and one thing that clients will always appreciate is any sort of information that will make taxes easier to handle.