I Live in Two States. Where Do I Pay Taxes?

When an individual lives, works, or owns property across state lines, determining where to pay state income taxes can become complex. State tax systems are not uniform, and each state maintains its own rules for establishing tax obligations. This often leads to situations where individuals might be subject to tax in more than one state, requiring a clear understanding of state-specific tax laws to ensure compliance and avoid liabilities. The intricacies arise from varying definitions of residency, income sourcing rules, and mechanisms designed to prevent multiple states from taxing the same income.

Determining Your Tax Residency

State tax residency dictates which state has the primary right to tax an individual’s income. Most states consider two main factors: domicile and statutory residency. Domicile refers to an individual’s true, fixed, and permanent home, the place where they intend to return after any period of absence. An individual can only have one domicile at a time. Establishing a new one requires demonstrating a clear intent to abandon the old domicile and establish a new permanent home.

States consider various factors to determine an individual’s domicile, including:
The location of their primary home and family
Where they are registered to vote
The state that issued their driver’s license and vehicle registrations
The location of bank accounts
Professional licenses
Where the individual spends the majority of their time

States employ a “facts and circumstances” test, meaning no single factor solely determines domicile. Instead, a combination of these factors is weighed to understand an individual’s overall living patterns and intent. For instance, maintaining a primary residence, registering vehicles, and obtaining a driver’s license in a new state while severing ties with the old state can collectively indicate a change in domicile.

Statutory residency is based on physical presence in a state for a certain number of days, regardless of an individual’s declared domicile. Many states utilize a “183-day rule,” where spending more than half the year (183 days or more) in a state can deem an individual a statutory resident for tax purposes. Even if an individual’s domicile is in another state, meeting this physical presence threshold can subject them to the state’s income tax on all their income. Your resident state generally has the right to tax all of your income, regardless of where it was earned.

Taxing Income Based on Source

States have the authority to tax income earned within their borders, even if the individual earning that income is not a resident of that state. This concept is known as “source income” or “sourcing.” It means that income derived from activities or property located within a specific state is subject to that state’s taxation, regardless of the taxpayer’s residency.

Common examples of income sourced to a state include wages for work physically performed within that state’s boundaries. If an individual commutes across state lines for employment, the state where the work is performed will generally claim the right to tax those wages. Business income generated from activities conducted within a specific state is also considered source income for that state.

Rental income from real property, such as a house or apartment, is sourced to the state where the property is physically located. Any gains realized from the sale of real estate are sourced to the state where the property resides. These principles apply even if the taxpayer is a non-resident for tax purposes in the state where the income is sourced.

The rules for sourcing income vary by state and depend on the type of income. For example, some states have specific guidelines for sourcing income from services, which might involve considering where the benefit of the service is received rather than where the service is physically performed. Businesses operating across state lines must analyze each state’s sourcing rules to determine how income should be apportioned and taxed.

Mechanisms to Prevent Double Taxation

To prevent taxpayers from paying income tax on the same income to two different states, mechanisms are in place. The primary method is the “credit for taxes paid to other states.” This allows a taxpayer’s resident state to grant a credit for income taxes paid to a non-resident state on income also subject to tax by the resident state. This credit alleviates the burden of double taxation when an individual earns income in a state where they are not a resident.

The credit limits the amount to the lesser of the tax actually paid to the non-resident state or the amount of tax that would have been due on that income in the resident state. For example, if a taxpayer paid $1,000 in tax to a non-resident state on certain income, but their resident state would have only taxed that same income by $800, the credit would be capped at $800. This limitation ensures the credit does not reduce the resident state’s tax liability below what it would have been if no income was earned in another state. The amount of tax reported for this credit is the actual tax calculated on the other state’s return, not just the amount withheld from a paycheck.

Another mechanism to simplify tax filing and prevent double taxation is “reciprocal agreements” between certain states. These agreements allow residents of one state to work in a neighboring state without having income taxes withheld for the non-resident state on certain types of income, primarily wages. This means an individual living in State A but working in State B, if those states have a reciprocal agreement, would only pay income tax to State A, their state of residence.

Reciprocal agreements simplify the filing process for commuters, as they generally only need to file a tax return in their home state. These agreements are specific and vary by state and income type. Not all states have reciprocal agreements, and terms can differ. If no agreement exists, the taxpayer typically files a non-resident return in the work state and claims a credit for taxes paid on their resident state return.

Applying the Rules to Common Situations

The principles of tax residency, income sourcing, and double taxation prevention apply to various real-world scenarios. For individuals who live in one state but commute to work in another, the commuter scenario demonstrates these rules. If a person lives in State A (their resident state) but works physically in State B (a non-resident state), State B will tax the wages earned there as source income. State A, as the resident state, will tax all of the individual’s income, including the wages earned in State B, but will then provide a credit for the income taxes paid to State B on those wages. This ensures the income is not taxed twice.

For individuals who split their time between states, often called “snowbirds” or seasonal residents, the interplay between domicile and statutory residency is relevant. A person might maintain their primary home and domicile in State A but spend several months each year in a vacation home in State B. If State B considers them a statutory resident based on days spent there, both states might claim the right to tax their full income. In such cases, tracking days spent in each state is important, and the credit for taxes paid to other states helps avoid double taxation. If the individual is merely a temporary visitor in State B and does not meet statutory residency thresholds, only income sourced to State B (such as rental income from a State B property) would be taxed by that state.

Remote work has introduced complexities in income sourcing. If an individual lives in State A but works remotely for a company located in State B, the rules for sourcing that income can vary. Some states might tax based on the employer’s location, while others focus on where the work is actually performed, which is the employee’s physical presence in State A. This evolving area of tax law can lead to situations where both states assert taxing authority, requiring the individual to understand the specific rules of both states and potentially utilize credits for taxes paid to other states. Some states have “convenience of the employer” rules that can complicate remote work taxation, potentially sourcing income to the employer’s state even if the work is performed elsewhere.

Individuals owning multiple properties also face tax considerations. If a primary residence is in State A, but a rental property or vacation home is owned in State B, any rental income generated from the State B property is considered source income for State B. State B will tax this income, and the taxpayer will typically file a non-resident return there. State A, as the resident state, will also tax this rental income but will then allow a credit for the taxes paid to State B. Understanding the specific sourcing rules for different income types and the application of tax credits is important for managing multi-state tax obligations. Reviewing the specific requirements of all states involved in multi-state living arrangements is advised.