More Tax Tips for People Living and Working in Different States
5: Research Reciprocal Agreements
Although tax rules and regulations vary from state to state, some states have attempted to ease the burden on people who live in one state and work in other states. This is particularly true of states that border one another, such as Iowa and Illinois. In these states, for example, someone who works in Iowa but lives in Illinois does not have to pay Iowa income tax. Instead, the worker will only pay income tax in the state in which he or she lives — in this case, Illinois. This is known as a reciprocal agreement.
Not only do reciprocal agreements simplify the tax process (you'll only file in one state instead of two), some reciprocal agreements actually exempt workers from paying income taxes on wages earned in a nonresident state. States with reciprocal agreements include Illinois, Indiana, Iowa, Kentucky, Maryland, Michigan, Minnesota, Montana, New Jersey, North Dakota, Ohio, Pennsylvania, Virginia, West Virginia and Wisconsin. Most reciprocal agreements apply only to neighboring states.
There are a couple of important exceptions worth noting. The District of Columbia allows residents of any U.S. state an exemption from D.C. income taxes, although they still must file in their home states. Other multi-state regions aren't quite as accommodating. In fact, some would even argue that three states in particular are overtaxing workers. Find out which ones below [source: Moreno].
4: Taxation in the New York Tri-state Area
There are a number of states with reciprocal agreements that make exceptions for people who work in one state and live in a neighboring state. In short, these workers only pay taxes in their home state rather than having to file and pay taxes in both states.
New York, Connecticut and New Jersey, however, are a clear exception to the reciprocity rule. These three states do not have a reciprocal agreement, despite the fact that many workers commute from one of the three states to another. This means that if you live in Connecticut and commute to New York for work, you'll need to pay taxes in Connecticut and then pay them again in New York.
There is a bit of silver lining, though. Most residents who live and work in states where there are not reciprocal agreements, and where they have to pay taxes as a resident and a non-resident, can take advantage of a tax credit on one return for taxes paid on another. For more specific information about how to file dual state tax returns, continue reading below [source: Pinho].
3: File in the Right Order
Most people filing a state tax return only need to do so in a single state. For those who live in one state and work in another, the process is a bit more complicated.
There's a specific order in which you'll need to file multiple state tax returns. First, you'll file in the non-resident state or states in which you've earned income. For example, if you were not a resident of Missouri, but worked there for three months as a contractor, you'll need to submit your tax return to Missouri before submitting one to your home state. Keep in mind, you'll only need to do a tax return in your home state if it levies income tax against its residents.
The reason for filing in the non-resident state first is to determine the amount of credit or deduction you can claim for taxes already paid in other states before completing your resident or "home" state taxes. Even if you don't owe taxes in your home state — perhaps your only income for the tax year was earned in another state — you may still need to file a state tax return to get a refund [source: Caplinger].
2: Telecommuting Complications
For many years, Sarah worked and lived in New Mexico, the same state in which her employer was located. Then she and her family moved to Colorado, where she continued to work for her employer.
So what's the problem? The solution is simple enough, right? Sarah will need to file taxes in the state in which she lives and works: Colorado. Of the 41 states that tax personal income, 36 of those states have a physical presence rule, and Colorado is one of them. In short, this means Sarah's wages will be taxed where the work is done.
If Sarah lived in one of the five states that does not follow the physical presence rule, she'd have different rules to follow. The wages she earned would be taxable in the state where she lives and the state where her employer is located.
There are a couple of exemptions, including an exemption for work that could only be performed out of state. An employee who works in sales and covers an out-of-state sales territory is a good example of this exemption. However, because Sarah works in data entry, she telecommutes for convenience, not necessity. She'll pay taxes in both states [source: Kreisman].
1: Corporate Tax Implications
Telecommuting from another state may not pose a problem for you, but it could for your employer. When a telecommuter works for an employer in another state, the employer establishes nexus, or a business presence, in the telecommuter's state. And this can have tax consequences. The employer may need to file a corporate income tax return in the state in which their employee is working [source: Kreisman].
In general, these corporate tax implications have little to do with your personal income tax. Although you could get some blowback from an employer who is reticent to spread its corporate reach to another state for just one employee, there's not much to worry about from an individual standpoint, aside from being phased out. The truth is, the location of your employer's corporate offices has nothing to do with your tax responsibility. You'll pay taxes in the state or states where you work, as long as they tax personal income.
If, however, your employer mistakenly withholds tax in the state in which it is headquartered, you'll want to voluntarily file a return in that state. That way, you can get any refund you are due [source: Moreno].
Last editorial update on Jan 15, 2019 12:11:04 pm.
Author's Note: 10 Tax Tips for People Working and Living in Different States
On one hand, it seems pretty simple. If you work in a state that taxes personal earnings, you'll need to file a return in that state. On the other hand, the specifics can seem contradictory and confusing -- a patchwork of regulations and rules. And, like most tax regulations, the rules are different for employees than they are for contractors. Consulting a tax professional may be your best bet.
Related Articles and Resources
- Caplinger, Dan. "Three Reasons You May Have to File Tax Returns in Multiple States." Daily Finance. April 8, 2014. (Nov. 13, 2014) http://www.dailyfinance.com/2014/04/08/filing-tax-returns-multiple-states/
- Dzombak, Dan. "These States Have No Income Tax." USA Today. April 26, 2014. (Nov. 6, 2014) http://www.usatoday.com/story/money/personalfinance/2014/04/26/these-states-have-no-income-tax/8116161/
- IRS. "Five Misconceptions About Your State Tax Refund Status." March 3, 2014. (Nov. 6, 2014) http://www.irs.com/articles/misconceptions-about-state-tax-refund-status
- Kreisman, Bruce. "State Tax Consequences of Telecommuting." KOS. Jan. 4, 2014. (Nov. 6, 2014) http://www.koscpa.com/newsletter-article/state-tax-consequences-telecommuting/
- Massachusetts Department of Revenue. "Frequently Asked Questions Nonresidents and Part-Year Residents." (Nov. 6, 2014) http://www.mass.gov/dor/individuals/filing-and-payment-information/personal-income-tax-faqs/nonresidents-and-part-year-residents-faqs.html
- Moreno, Tonya. "Reciprocal Agreements: States that Do Not Tax Certain Out of State Workers." (Nov. 6, 2014) http://taxes.about.com/od/statetaxes/a/reciprocal-agreements.htm
- Pinho, Rute. "State Income Taxes on Income Sourced to Other Jurisdictions." OLR. Aug. 30, 2012. (Nov. 6, 2014) http://www.cga.ct.gov/2012/rpt/2012-R-0397.htm
- Povich, Elaine. "'Road Warrior' State Income Tax Laws Vary Widely." The Pew Charitable Trusts. Dec. 12, 2013. (Nov. 6, 2014) http://www.pewtrusts.org/en/research-and-analysis/blogs/stateline/2013/12/12/road-warrior-state-income-tax-laws-vary-widely
Many Americans don't think about their tax bills until the new year. But there are things you need to do before Dec. 31 if you want to pay less later.