Lets say you work in Chicago and live in Chicago but put your home address as somewhere in Indiana. Then every week you collect the mail that is being sent to you in Indiana. Wouldn't you save a lot of money assuming the taxes are lower? What prevents people from doing this?
The very short version is "laws". The more helpful version is that every state has its own taxation requirements. For instance, if you work in Illinois you are required to file appropriate forms stating what you say your residence is.
Every state works a little differently, so you'll need to review every involved state. Here is a law firm's advice on establishing state "domicile" (residency).
The short version is that you will be required to tell the state you get paid in, and the state you claim to live in (if they have a tax or other reason to care), with yearly filed forms what your status is. Many states you might work in don't actually care where you claim to reside - you pay taxes regardless.
All states have figured out that this is a 'great' and seemingly 'easy' way to dodge taxes, so in my experience if you work/live in multiple states it doesn't matter how honest or correct your taxes are - they will all often request more paperwork asking you to prove what you say about your residency is true. If you do not provide it, they will assume the truth is whatever gets them the most money, and the onus becomes on you to prove otherwise. And the documents they require quickly become non-trivial.
At one point I had to provide copies of birth certificates, driver license and registration, car insurance, lease(s), school records, a signed/notarized statement from myself asserting my proper status, W2s from every job, copies of tax returns in every state I filed and a copy of my federal return, etc. And I had to do something similar for every state I filed in. It all worked out fine - but every state was very keen to cut down on this form of tax fraud (this happened within the last few years).
States with low/no income taxes don't like being used for this, because they lose money too - those states generally rely on other taxes which you will contribute minimally to. States with income taxes where you work and claim not to live aren't keen on such a situation either, because they lose a primary source of income.
So all in all, this is a very well known issue among tax authorities, and they are legally entitled - and usually will nowadays - to demand you provide proof that you meet the legal requirements of the state in terms of domicile and tax status. If you cannot provide the proof, they will make you pay. If they catch you lying, this is tax fraud, and tax authorities really don't mind hitting you with penalties. If you've done this more than once, they will also automatically flag past returns to go back and check, and they are generally quite happy to refer you to the district attorney for additional 'handling', plus penalties. And on top of it, tax authorities have a very unusual presumption of innocence - which is that they tend not to have that. They can go back and say, "well, you were lying/wrong about this thing, so we will assume everything else is wrong and charge you appropriately" - and then you have to prove you aren't in the wrong for every item. This will generally mean you need a lawyer, and they add their own expense on top.
The name of the game is "some people get away with it - so they punish people extra hard to try to discourage you". So don't do it :)
Why stop at Indiana? Why not say you live in a tax haven in a completely different country, and not pay any taxes at all, even though you still remain in the same place?
Oh, it's called tax evasion. Right. That thing they talk about on TV all the time these days.
Many people actually do it (though it's usually a little bit more complex, they set up companies in those countries, and get the money through those companies). In some cases, it's actually even legal (see big corporations "parking" their international profits in tax havens to avoid taxation in the US), up to a certain point, though many countries are actively fighting those "loopholes".
But in many cases, it's actually just plain illegal. The country/state where you live in has laws that says you owe taxes on your income based on a number of conditions, such as your place of residence, the source of your income, and so on. In some cases, several jurisdictions may even have a valid claim to tax you (suppose you are an United States citizen living in France and working in Switzerland: all three have a reason to tax you).
There are then treaties to decide who you actually pay taxes to in those situations, but it can quickly become very complex.
If you just plain flat out lie about where you live, you'll end up being caught when they check (and they do check). You'll be asked to prove that you actually live where you claim you do. Rent, utility bills, grocery bills... If you can't prove it, you'll be taxed, and will probably have to pay penalties. And good luck reclaiming what you paid to the other state!
What prevents people from doing this?
- Laws (if you are lying about your residency)
- It won't work for income taxes
Wouldn't you save a lot of money assuming the taxes are lower?
According to the Illinois Department of Revenue:
you must file Form IL-1040 and Schedule NR if
- you earned enough taxable income from Illinois sources to have a tax liability
So just claiming you live in Indiana won't stop you from owing income tax in Illinois. Plus Indiana might compensate for lower income taxes with higher property taxes, so you might actually may more taxes with this scheme.
(I see in the comments you only want to create a PO Box, so this may not apply, but it does apply to other situations where people legitimately live across state lines).
NBA players actually have to pay tax to all states that they play in. Otherwise, every player would move to a state that has no state income tax.
Some adjoining states have reciprocity agreements. In those cases it is where you live that determines which state taxes apply.
But if you aren't covered by one of those agreements. Then each state will try and determine if they can claim you.
The states set out in their laws what you need to do to claim residency. They look for things like which address do you have bills sent to, where are you registered to vote, where do you have your drivers license. There ra e also exemptions carved out for active duty military, college students, and workers who are on temporary assignments.
The risk is being charged with tax fraud. You could be hit with interest and penalties. In your example Illinois would claim taxes going back for more years than Indiana will be willing to refund. They could also hit you with other fines for not registering the vehicle, or getting a drivers license, or paying a personal property tax.
Ways you could get caught. Parking a car with an out of state license plate for too many nights. When you get to a point when you need to apply for a benefit from the other state.
I knew somebody who moved states, but didn't tell their company for years. Then their child wanted to go to a school in their new state. They weren't allowed to register for school until they resolved all the issues. It cost them a ton of money.
To offer a different point of view from the other answers. Each state will have rules about when people will owe income (or other taxes) and what income is to be included in that calculation.
There's nothing stopping you from reading the rules and arranging your life such that you avoid a state's income tax. Some states are aggressive, if I remember correctly, you owe New York income tax from all sources of income by simply owning property in the state regardless of whether or not you even set foot in the state. Some states may require that you be physically present in the state more than 180 days.
Fact of the matter is there will be rules. You just have to follow the rules.
It's difficult if not impossible to do if you actually live in Chicago, and just have a mail drop in the other state. You'd need to establish effective residency there, by e.g. owning a residence, spending time there, maintaining voter registration, driver's license and so on. All of that is likely to cost more than you'd save in taxes unless you are a) really rich; or b) actually do live in the second state, and just work in the first.
As an example of b, for a couple of years I spent alternate weeks working in California & living in rented lodgings there. The other weeks I'd work from my actual (owned) home in Nevada, where I maintained everything that goes into establishing residency. As a consequence, I only had to pay California nonresident tax on the portion of my income that came from the California client, not on income that I got from my other clients. The critical point here is that I actually WAS a Nevada resident, and had been for many years before taking the California job, so there was no lying about my resident status. It was never questioned, but I could have easily proved it if it had been.
PS: And per comments above, the only reason this actually benefitted me is because only a fraction of my income was from California. Had I had only a single W-2 job in California, I think (though I've never actually worked it out) that I would have paid as much whether I was a resident or non-resident.
Because there are much easier ways to cheat on your taxes
While moral obligations and legal threats play a part, I believe the main reason is this would be an extremely expensive, difficult way to cheat your taxes.
Why (Low/Middle Income)
1) You must establish residency in a state you don't live in. A P.O. box won't cut it. You've got to show a lease or utility bills. That involves buying or leasing an actual place to live, which will be several hundred a month.
2) Per above, a low/middle net worth individual would spend more faking a residence than they'd save. It's all risk and no reward.
3) Furthermore, low/middle net worth people likely work a 9-5 job, where taxes are taken out of their paychecks before they even see the money. Claiming they don't owe state taxes is likely going to raise a red flag.
Why (High Income)
For high net worth individuals, it's a bit different. They can afford a lake house in a 0% income tax state, and may actually visit a weekend or two a month to get the mail and enjoy the view.
1) They can also afford a great accountant to figure out how to legally not pay taxes in the state they live in anyway.
2) High net worth individuals are likely already itemizing deductions, and figuring out how to make the mortgage interest deduction work in their favor. They've likely also set up companies that hold money and assets for them in a tax-advantaged way.
3) High net worth individuals (many retirees are in this camp) do move to states like Florida which have no income tax. If you're running a company that does business in another state, you may still be required to pay some type of corporate income tax based on where the money was earned.
According to the Illinois Department of Revenue, you must file an Illinois income tax return if “you earned enough taxable income from Illinois sources to have a tax liability[.]” There is a form for residents of Iowa, Kentucky, Michigan or Wisconsin to fill out exempting them from withholding, but not Indiana. “If you received wages, salaries, tips, and commissions from Illinois employers, you are not required to pay Illinois Income Tax on this income. This is based on reciprocal agreements between Illinois and these states.”
So this might be useful if you earn a lot of passive income from investments out-of-state (although in that case the way to make them tax-free legally is to buy muni bonds), or if you want to work in Indiana but live in Chicago, but not if you work and live in Illinois.
Most people who work in Illinois would have state income tax withheld, although the hypothetical tax cheat would have several ways around that.
I'm surprised no one has yet mention an important reason: ignorance.
Your question (and other answers) assumes people are aware of all the benefits and costs of making such decision. However, we are not rational machines. In reality, we have limited knowledge of the world. There is an amazing article about a recent book on the topic ("The knowledge illusion") here. A nice quote:
Over the last few decades, the ideal of the rational individual has been attacked from all sides. Postcolonial and feminist thinkers challenged it as a chauvinistic Western fantasy, glorifying the autonomy and power of white men. Behavioral economists and evolutionary psychologists have demonstrated that most human decisions are based on emotional reactions and heuristic shortcuts rather than rational analysis, and that while our emotions and heuristics were perhaps suitable for dealing with the African savanna in the Stone Age, they are woefully inadequate for dealing with the urban jungle of the silicon age.