Plan on Ohio: Ohio's new Bright-Line Residency Test adds simplicity and opportunities.

Before leaving office in January 2007, Gov. Bob Taft signed into law Sub. H.B. 73, called the 2007 Bright-Line Residency Test for Ohio personal income tax and school district income tax purposes. For taxable years beginning on or after Jan. 1, the new law replaces Ohio's first bright-line residency tests enacted in 1993. The 2007 Bright-Line Residency Test essentially allows nonresidents up to six months in Ohio while still retaining their nonresidency status. As a result, individuals now have added flexibility to reduce or eliminate Ohio and school district personal income tax.

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Tax practitioners should immediately review the potential impact of the 2007 Bright-Line Residency Test with any clients who already have a residence outside Ohio to determine whether they may benefit from the new bright-line test for taxable year 2007. In addition, current nonresidents of Ohio should be advised about the increased contact periods and additional reporting requirements of the 2007 Bright-Line Residency Test.

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Background

A review of Ohio's historical treatment of domicile and residency for income tax purposes is necessary to understand the 2007 Bright-Line Residency Test.

Ohio's personal income tax is imposed on individuals who reside, earn or receive income in Ohio. Individuals who reside in Ohio are taxed differently from nonresidents who merely earn or receive income in Ohio. In general, residents are taxed on their income from all sources, with a tax credit for income taxed by other states. Nonresidents are initially taxed on their income from all sources, but get a full tax credit for income not earned or received in Ohio, regardless of whether the nonresident paid income tax to another state. Because nonresidents pay Ohio tax only on their Ohio-sourced income, many Ohioans save Ohio taxes by establishing residency in a state either with a lower combined income tax rate than Ohio, which is most other states, or with no income tax at all (e.g., Florida, Nevada and Texas).

Changing one's residence from Ohio to another state was traditionally a rather complicated and confusing task. A person is considered an Ohio resident if "domiciled" in Ohio. A taxpayer's domicile is a permanent legal residence that the taxpayer intends to use for an indefinite or unlimited period, and to which, when absent, the taxpayer intends to return. The question of domicile is primarily a matter of intent. Historically, the Ohio Department of Taxation (ODT) and the courts have used a myriad of factors to measure this subjective standard of intent. Just a few of the factors that they have historically used to determine residency include:

* State of voter registration

* State of motor vehicle registration

* State of driver's license

* IRS service center used to file federal tax returns

* Location of bank accounts and lines of credit

* Location of major consumer goods purchases

* Location of professional service providers, such as attorneys, accountants and physicians

* Location of charitable organizations supported by the taxpayer

* Location of athletic and social club memberships.

The use of these and many other factors did not reduce the subjectivity of the residency determination.

Confusion before 1993

Due to this subjectivity, a persistent area of controversy between ODT and individual taxpayers was the question of an individual's residency status for Ohio personal income tax purposes. ODT spent significant audit resources in attempting to identify individuals who were avoiding Ohio income tax by improperly treating themselves as residents of another state. At the same time, individuals spent significant resources proving their bona fide change in residency. The resulting litigation created increasing uncertainty for both ODT and individuals.

To reduce the uncertainty of residency status, ODT, The Ohio Society of CPAs and the Ohio State Bar Association collaborated to develop a bright-line test of residency. The result of this joint effort was S.B. 123, referred to as the 1993 Bright-Line Residency Tests, which provided three "bright-line" tests to determine residency for Ohio individual income tax purposes.

The 1993 Bright-Line Residency Tests

The 1993 Bright-Line Residency Tests did not change prior law, but attempted to avoid subjectivity by providing three bright-line tests for purposes of determining residency for Ohio personal income tax purposes. That law applied to all taxable years ending on or after Oct. 29, 1993. The bright-line tests were based on the number of contact periods an individual had in Ohio. Individuals were considered having one contact period in Ohio if:

1) They had an abode located outside Ohio

2) They were away from that abode for a continuous period of time, however minimal, beginning at any time on one day and ending at any time on the next day (i.e., away overnight)

3) While away overnight from that abode, they spent at least some portion of two consecutive days in Ohio.

The three bright-line tests were as follows:

* The 120 Contact Periods or Fewer Test: Under this test, an individual was presumed not to be domiciled in Ohio if the individual had 120 contact periods or fewer in Ohio during the taxable year and had at least one abode outside Ohio for the entire taxable year. The presumption would become irrebuttable if, upon request of the tax commissioner, the individual timely provided a written statement, signed under penalties of perjury, representing that she had at least one place of abode located outside Ohio during the entire taxable year and that she was not domiciled in Ohio for any period during the taxable year.

* The 121 through 182 Contact Periods Test: Under this test, an individual was presumed to be domiciled in Ohio for the entire taxable year if she had more than 120 contact periods in Ohio, but fewer than 183, during the taxable year. However, the individual could rebut this presumption for all or any portion of the taxable year by providing a preponderance of evidence to the contrary.

* The 183 Contact Periods or More Test: Under this test, an individual was presumed to be domiciled in Ohio for the entire taxable year if she had 183 or more contact periods in Ohio during the taxable year. However, the individual could rebut this presumption for all or any portion of the taxable year by providing clear and convincing evidence to the contrary.

In 2000, Ohio added an additional 30 "free" contact periods (these are "contact periods" but are not considered as such for the aforementioned tests) if the individual spent any portion of either day of such contact period to provide services for no consideration to a charitable organization, to attend to a medical hardship of the individual or a relative, or to attend a funeral for a family member.

The 1993 Bright-Line Residency Tests provided some certainty for many individuals, especially to those who had 120 or fewer contact periods. However, for those who exceeded 120 contact periods, no true level of certainty or comfort existed and few taxpayers challenged the residency presumption of the second or third test. As a result, many former Ohioans who retired to warmer climates avoided extended stays in their native Ohio. Many policy makers and community leaders felt this situation deprived Ohio of the significant resources and benefits that these native Buckeyes could offer our state.

The New 2007 Bright-Line Residency Test

Ohio's new 2007 Bright-Line Residency Test provides more flexibility for current and former Ohioans, but it also adds new mandatory reporting requirements. The 2007 Bright-Line Residency Test law removes the three tests described above and provides what is essentially an "all or nothing" test for determining whether an individual is a nonresident for Ohio tax purposes. The likely result of the law change is that some taxpayers who have continued to pay income tax as Ohio residents may now be considered nonresidents for Ohio tax purposes. Further, current nonresidents may now be able to increase their Ohio connections with no adverse Ohio income tax impact.

The 2007 Bright-Line Residency Test retains the same definition for "contact period" as contained in the 1993 Bright-Line Residency Tests. An individual has one contact period with Ohio if, while away overnight from their non-Ohio abode, the person spends at least some portion of two consecutive days in Ohio.

* Example 1: If Mickie, who lives in Maine, flies into Dayton International Airport on May 1 for a meeting and flies out of Dayton and back to Maine on May 2, her visit will constitute one contact period in Ohio. Note that the ODT would undoubtedly count one contact period against Mickie even if her meeting was in Richmond, Indiana, and she spent the night in Indiana.

The total number of contact periods in Ohio does not have to be consecutive.

* Example 2: If Alison, who lives in New York, stays in Ohio from May 1 through July 31 (91 contact periods) and also the entire month of December (30 contact periods), she will have 121 contact periods in Ohio for the taxable year.

The 2007 Bright-Line Residency Test provides that an individual will be presumed to be not domiciled in Ohio, and therefore not an Ohio resident, if all the following are satisfied:

1) The individual has no more than 182 contact periods in Ohio during the taxable year

2) The individual has at least one abode outside Ohio during the entire taxable year