Do Federal Employees Pay State Taxes While Living Overseas?

Federal employees working overseas may still have state tax obligations depending on their residency status. Many states require expatriates to continue filing returns if they maintain ties such as property ownership, voter registration, or a driver’s license.

Understanding how state tax laws apply while stationed in another country is essential to avoid unexpected liabilities.

Residency and Domicile

State tax obligations for federal employees living overseas depend on residency and domicile, two classifications states use to determine tax liability. Residency is often based on physical presence, while domicile is tied to where a person intends to return after an absence. Domicile does not change unless a person takes clear steps to establish a new one.

Many states impose income tax based on domicile, meaning that even if a federal employee is stationed abroad for years, they may still owe state taxes if they have not formally changed their domicile. States like California and New York are particularly aggressive in asserting tax claims on individuals who maintain strong ties, such as a home, business interests, or family members residing in the state. These states often require clear evidence, such as selling property and severing financial connections, to prove a change in domicile.

Some states allow individuals to break domicile more easily, while others make it difficult. Virginia requires individuals to prove they have established a new domicile elsewhere, while South Carolina allows domicile to be abandoned with fewer formalities. The burden of proof typically falls on the taxpayer, and failure to demonstrate a change can result in continued tax obligations.

Foreign Posting Considerations

Federal employees assigned overseas often assume that living outside the U.S. exempts them from state tax obligations, but many states consider financial and legal connections when determining tax liability. Bank accounts, investment holdings, and professional licenses maintained in a state can justify continued taxation. Some states also scrutinize whether an individual continues to receive in-state benefits, such as reduced tuition for dependents at public universities.

The nature of an overseas assignment can also impact tax treatment. Temporary postings, where the expectation is to return to the original state, may not affect tax residency status. Long-term or indefinite assignments could serve as evidence that an individual no longer maintains sufficient ties to their former state. Some states provide guidance on how deployments or foreign assignments affect tax status, while others leave it to interpretation. Employees working under contracts that specify a return to the U.S. upon completion may find their tax obligations unchanged despite years abroad.

Military personnel benefit from the Servicemembers Civil Relief Act (SCRA), which allows them to maintain their original state of residence for tax purposes regardless of where they are stationed. Civilian federal employees, however, must navigate each state’s tax laws individually. Some states offer exemptions for income earned while working overseas, but these policies vary significantly. For example, Hawaii allows a foreign income exclusion under specific conditions, while New Mexico provides exemptions for residents who spend a defined period outside the state.

Special Provisions in Certain States

Some states have unique tax policies that impact federal employees living abroad. Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming do not impose individual income taxes, so those originally domiciled in these states generally have no state tax obligations while overseas. Tennessee and New Hampshire tax only interest and dividend income, which may still be relevant for individuals with substantial investment earnings.

A few states impose exit taxes or require additional filings when individuals attempt to sever tax ties. California applies a “Safe Harbor Rule” for those leaving on temporary contracts, allowing exemption from state taxation if they meet a strict 546-day absence requirement without significant ties remaining. New York applies a statutory residency test that can lead to taxation if an individual maintains a permanent place of abode and spends more than 183 days in the state, even if they claim domicile elsewhere.

Income Reporting Obligations

State tax authorities typically require individuals to file annual income tax returns if they have a continuing tax obligation, regardless of their physical location. Even if no tax is owed due to credits or exclusions, failure to file can trigger penalties, audits, or assessments based on assumed income. Some states impose automatic late-filing penalties, often starting at 5% of unpaid taxes per month, with maximum penalties reaching 25%. Interest on unpaid liabilities accrues at rates typically tied to the federal short-term rate plus a state-specific percentage.

Many states require taxpayers to report all worldwide income, even if a portion is excluded federally under the Foreign Earned Income Exclusion (FEIE) or a Foreign Tax Credit (FTC) is applied. Unlike federal tax obligations, which allow exclusions for income earned abroad up to $126,500 in 2024, most states do not provide similar relief. This means that wages, self-employment earnings, rental income, or pension distributions received while overseas may still be fully taxable at the state level.

Changing State Tax Responsibilities

Federal employees who want to minimize or eliminate their state tax obligations while living overseas must take deliberate steps to change their domicile. Simply moving abroad is not enough; states require clear and convincing evidence that an individual has abandoned their prior domicile and established a new one elsewhere.

Effective actions include selling or renting out property, closing in-state bank accounts, relinquishing a driver’s license, and registering to vote in a different jurisdiction. Establishing residency in a state with no income tax can be a strategic move, but it requires more than just a mailing address. States like Texas and Florida allow individuals to declare residency through vehicle registration, homestead exemptions, and professional licensing. Without these steps, a state may continue to assert tax jurisdiction, particularly if the individual maintains a presence through family ties or business interests.