Filing Taxes When You Live in Indiana and Work in Illinois

Living in Indiana while working in Illinois is a common scenario that creates a specific set of tax obligations. As an Indiana resident earning income from an Illinois employer, you must understand the tax rules of both states to ensure proper filing and avoid double taxation.

Understanding Your Tax Obligations

Indiana and Illinois do not have a tax reciprocity agreement. This means that as an Indiana resident, wages earned from an Illinois employer are subject to income tax in both states. Illinois, as the state where the income is earned, taxes it first. Indiana, as your state of residence, also taxes all of your income, regardless of where it was earned.

To prevent double taxation, Indiana provides a “credit for taxes paid to another state.” This credit reduces your Indiana tax liability by the amount of tax you paid to Illinois on those same wages. This system ensures you ultimately pay a total tax amount close to the higher of the two states’ tax rates.

This process applies to employee compensation like wages, salaries, and commissions. It does not extend to other types of income, such as earnings from self-employment or rental properties located in Illinois, which have their own distinct tax rules.

Required Tax Forms and Preparation

Your Illinois employer is required to withhold Illinois state income tax from your pay. Your year-end Form W-2 will show your total wages and the amount of Illinois income tax withheld. To file correctly, you will need to submit returns for both states. For Illinois, you will file a nonresident return, and for Indiana, you will file a resident return with schedules to claim the tax credit.

The primary forms you will work with are:

• Illinois Form IL-1040 and Schedule NR: This is the nonresident return you file with Illinois to report your Illinois-source income and calculate your Illinois tax liability.
• Indiana Form IT-40: This is the standard income tax return for Indiana residents.
• Indiana Schedule 6: This form is filed with your IT-40 to claim the credit for taxes you paid to Illinois.
• Indiana Schedule CT-40: This schedule is used to calculate the local income tax you owe based on your Indiana county of residence.

Filing Your State Tax Returns

You must follow a specific order when filing to ensure the credit is calculated correctly. First, complete your Illinois nonresident tax return (Form IL-1040 with Schedule NR). You will report only the income you earned in Illinois, and this return will determine your official tax liability to Illinois. The credit you claim on your Indiana return is based on the actual tax owed to Illinois, not just the amount that was withheld.

Second, prepare your Indiana resident tax return (Form IT-40). You must report all of your income on this return, including the wages earned in Illinois. After calculating your initial Indiana tax, you will complete Schedule 6 to claim the credit for the taxes paid to Illinois. The wages earned in Illinois are also subject to Indiana county tax, which you will determine using Schedule CT-40.