Do I Pay State Taxes Where I Live or Work?

Understanding where state income taxes are owed, whether in the state of residence or employment, is important for tax compliance, especially for individuals living and working across state lines. This article clarifies how state income taxes are determined, focusing on tax residency and income sourcing. It also explains how potential double taxation is addressed when multiple states claim an individual’s income.

Determining Your Tax Residency

State tax residency dictates a state’s ability to tax an individual’s income. The primary determinant of residency is “domicile,” referring to an individual’s true, fixed, and permanent home, where they intend to return when absent. An individual can only have one domicile at a time, regardless of temporary residences.

States consider various factors when assessing domicile. These include voter registration, driver’s license issuance, addresses for legal documents and bank accounts, and professional services like doctors and accountants. Other factors involve the location of family, valuable personal possessions, and habits indicating primary attachment to a state.

Beyond domicile, many states have “statutory residency” rules. An individual is a statutory resident if they maintain a permanent abode in a state and spend significant time there, often over 183 days within a tax year. Meeting these statutory presence requirements can subject an individual to full income taxation in that state, even if their domicile is elsewhere. If classified as a resident, by domicile or statute, a state taxes all of an individual’s income, regardless of where it was earned.

Understanding Income Sourcing

While residency determines a state’s right to tax worldwide income, “income sourcing” dictates where specific income types are considered earned. This concept is relevant for non-residents, as states tax non-residents only on income derived from sources within their borders. For instance, if an individual lives in one state but works in another, the state where the work is physically performed claims the right to tax that earned income.

Wages and salaries are sourced to the location where services are physically rendered. If an employee performs work in a state, the income earned is sourced there. Income from business activities is sourced where operations occur, and rental income is sourced to the property’s physical location.

The rise of remote work introduced complexities in income sourcing. Some states apply a “convenience of the employer” rule, sourcing wages to the employer’s state if the employee works remotely for their own convenience. This rule means wages may still be sourced to the employer’s state even if work is performed elsewhere. Understanding these sourcing rules determines which non-resident states can impose an income tax liability.

Navigating Multiple State Tax Obligations

When an individual resides in one state and earns income in another, both states may claim to tax the same income. The resident state taxes all of the individual’s income, regardless of origin, while the non-resident state where income was earned taxes the income sourced there. This could lead to double taxation, but specific provisions alleviate this.

One mechanism to prevent double taxation on wages is a “reciprocal agreement” between states. Under these agreements, two states agree that wages earned by a resident of one state working in the other are only taxed in the state of residency. This eliminates the need to file a non-resident return in the work state for wages, simplifying compliance. If such an agreement is in place, the employer withholds income tax only for the employee’s resident state.

In the absence of a reciprocal agreement, the primary method to avoid double taxation is a “credit for taxes paid to other states.” States provide residents with a tax credit for income taxes paid to another state on income also taxed by the resident state. This credit reduces the tax liability in the resident state by the amount paid to the non-resident state, up to the tax owed on that income in the resident state. The credit allocates tax revenue between states, ensuring the taxpayer’s total liability does not exceed what they would have paid to the higher-taxing state.

State Income Tax Filing

Individuals facing multi-state income scenarios need to file at least two state income tax returns. A non-resident return is required for any state where income was earned and sourced, assuming no reciprocal agreement is in effect. Subsequently, a resident return must be filed in the individual’s home state, reporting all worldwide income.

When claiming a credit for taxes paid to another state, first complete the non-resident state’s tax return. This determines the income taxed and the specific tax amount paid to that state. This calculated payment is then used to compute the credit on the resident state’s return.

Accurate record-keeping, including W-2 forms and pay stubs detailing income and withholdings by state, aids multi-state income tax preparation. State departments of revenue provide specific forms and instructions on their websites. These resources explain the procedural steps for filing and claiming any applicable credits.