By Jimmy Vielkind and Paul Berger 

Tax revenues for New York City and the state are on the line as some of the region's wealthiest residents flee to the suburbs or beyond while employers keep out-of-state commuters in their homes.

Both the state and city rely disproportionately on the wealthiest taxpayers to fund social services such as schools, hospitals and police officers. Before the coronavirus pandemic hit, people who typically commuted into New York City but live in New Jersey or Connecticut paid New York taxes for income earned in the state.

That allocation could change depending on how the states interpret rules on telecommuting, tax professionals say.

Meanwhile, other taxpayers who own both a New York City residence and a second home outside the city might try to shift their legal domicile to the latter, in hopes of escaping the city's higher combined tax rates.

The stakes are high for such taxpayers because residents of New York pay state, and city, income taxes on their investment earnings and dividends, which could be much higher than their compensation.

New York's revenues are already $13.3 billion, or about 14%, below projections. The state is delaying payments and could cut outlays to school districts and municipalities if a federal aid package isn't approved.

"We have to pay attention to that because we do have a very progressive tax code," State Budget Director Robert Mujica said, which means wealthier people pay higher rates and bring in more revenue.

Lawyers and accountants say New York auditors are aggressive in determining a taxpayer's domicile, which is defined as a true home to which they always intend to return.

"There is no one bulletproof thing you can do to suddenly change your domicile. Auditors look at multiple aspects of your life, and it's a judgment call," said Joseph Endres, a partner at the Hodgson Russ law firm who specializes in tax work.

One 49-year-old tech entrepreneur told The Wall Street Journal he and his family have moved permanently to their second home in the Hudson Valley from Manhattan. The restaurants, office meetings, opera and theater performances that previously bound him and his family to the city have disappeared, he said, and probably won't return anytime soon.

For tax purposes, he says, he and his peers are aware that if their children still attend school in the city, it is hard to argue the family has left. The man is considering pulling his children from the city's elite private schools and is looking at public and private schools in the suburbs. He estimates that if he can persuade the city he is no longer a resident he will save more than $100,000 a year in city taxes alone.

Schools in the Hamptons, a Long Island refuge popular with wealthy families, say they have seen a surge in inquiries from families leaving the city.

A spokeswoman for New York City said officials are concerned about the potential impact of residence changes.

In 2016, income taxes accounted for about one-fifth of the city's tax revenue. That year, about 25,000 people with incomes of more than $1 million accounted for less than 1% of the city's tax filers but accounted for almost 40% of income-tax collections, according to the city's Independent Budget Office. Just 1,400 filers with incomes of $10 million or more accounted for 17% of revenues.

Half of New York state's income-tax revenue comes from the highest-earning 2% of taxpayers -- an estimated 188,000 people -- and Mr. Mujica said the state closely monitors migration.

"We also heard many of the same stories after 9/11, that people moved out of the city temporarily to other places and didn't want to come back to New York because of the fear that was there," Mr. Mujica said. "The reality is that over time, New York has come back and it's come back stronger than it was before."

A more immediate issue for the state involves telecommuting. Roughly 1.3 million taxpayers with domiciles in other states generated $7.9 billion in tax liability in New York in 2017, a spokesman for the New York State Department of Taxation and Finance said.

Work for a New York-based company performed remotely is still taxable in New York if the telecommuting took place for the convenience of the employee. Mr. Endres said he believed taxpayers could make a strong case that working remotely because an office was ordered closed as a result of the coronavirus meant they were teleworking out of necessity, and not subject to New York taxes.

One 40-year-old investment banker who lives in Connecticut but works in Manhattan, and now is telecommuting, said he was worried about receiving a Connecticut tax bill while his firm withholds tax money for New York.

E.J. McMahon, research director of the Empire Center for Public Policy, a fiscally conservative think tank, said Connecticut residents filed 83,534 New York returns in 2017 with an average New York-source income of $222,898.

New Jersey residents filed 421,427 New York state tax returns in 2017, reporting average New York-source income of $140,054, Mr. McMahon said. He estimated two-thirds were daily commuters, based on census data.

Mr. Mujica declined to estimate the potential impact, which won't become clear until next year, when people start filing 2020 income-tax returns. A New York tax department official said there was no change to the way the agency interprets the convenience-of-the-employee rule for telecommuting. They declined to comment on how it would be interpreted in the future.

On its website, New Jersey's Department of Taxation said that during the pandemic, "wage income will continue to be sourced as determined by the employer in accordance with the employer's jurisdiction."

A spokesman for the Connecticut Department of Revenue Services said it was developing guidance on telecommuting rules "that will provide fair and equitable treatment of Connecticut-resident individuals, as well as Connecticut-based businesses."

--Julia-Ambra Verlaine contributed to this article.

Write to Jimmy Vielkind at Jimmy.Vielkind@wsj.com and Paul Berger at Paul.Berger@wsj.com

(END) Dow Jones Newswires

May 25, 2020 09:14 ET (13:14 GMT)

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