Illinois vs California: Tax Rules for Living in One State and Working in Another

Living in one state while working in another can create tax complications, particularly in states like Illinois and California, which have different tax structures. Understanding how each state determines tax obligations is essential to avoid double taxation or unexpected liabilities.

Each state has its own rules for residency, income allocation, and tax credits, affecting how much you owe and where you file. Knowing these distinctions helps ensure compliance and minimizes unnecessary payments.

State Residency Rules

Determining residency for tax purposes can be complex, particularly when states use different criteria for establishing domicile and statutory residency. Illinois and California each have distinct approaches that significantly impact tax obligations.

Illinois considers an individual a resident if they maintain a permanent home in the state and intend to return after any temporary absence. The Illinois Department of Revenue evaluates factors such as voter registration, driver’s license issuance, and property ownership. Even if someone spends most of the year outside Illinois, maintaining strong ties—such as an Illinois driver’s license or property—can still result in being classified as a resident.

California takes a broader approach, focusing on an individual’s “closest connections.” The Franchise Tax Board examines where a person maintains their primary home, where their family resides, and where they conduct financial and social activities. California also has a statutory residency rule: spending more than nine months in the state creates a presumption of residency unless proven otherwise.

Nonresident Tax Liability

Earning income in a state where you do not reside often results in tax obligations. Both Illinois and California tax nonresidents on income earned within their borders but enforce these taxes differently.

Illinois taxes nonresidents on wages earned within the state under its source-based taxation system. If a person works in Illinois but lives elsewhere, they must file a nonresident return (Form IL-1040 and Schedule NR) to report Illinois-sourced income. The state’s flat income tax rate of 4.95% applies, and there are no local income taxes. Illinois does not impose a “convenience of the employer” rule, meaning remote workers owe Illinois tax only if they physically work in the state.

California takes a more aggressive approach. Anyone earning California-sourced income must file a nonresident return (Form 540NR). Unlike Illinois, California has a progressive tax system, with rates ranging from 1% to 13.3% in 2024. Higher earners working in California may face significantly higher tax liabilities. The state also scrutinizes whether business activities, consulting work, or temporary assignments create a tax obligation.

Beyond wages, nonresidents may owe California taxes on stock options, bonuses, or business income derived from California clients. The Franchise Tax Board closely examines these earnings to determine if they should be taxed at California’s rates, leading to disputes and court cases where taxpayers challenge the state’s interpretation of income sourcing rules.

Allocation of Wages

When working in one state and living in another, wages must be allocated correctly to ensure accurate tax payments. Illinois and California use different methods for determining taxable income.

Illinois taxes only the portion of income earned while physically working in the state. If an employee splits time between Illinois and another state, they must calculate what percentage of their wages were earned in Illinois and report only that portion. This is typically done using workdays or hours spent in Illinois compared to total workdays in the year. Employers often withhold Illinois taxes based on where the work is performed, but employees should verify this to avoid underpayment or overpayment.

California applies a more complex approach, particularly for nonresidents with income tied to California-based employers. The state considers not just where work is performed but also how income is structured. Bonuses, stock options, or deferred compensation linked to work done in California may still be subject to California tax even if received after leaving the state. The Franchise Tax Board uses apportionment methods to determine how much of these earnings are taxable, often requiring detailed record-keeping to justify exclusions.

Credits for Taxes Paid

When earning income in both Illinois and California, taxpayers may face taxation from both states on the same earnings. Tax credits help mitigate this, but the rules differ.

Illinois allows residents to claim a credit for taxes paid to other states on income also subject to Illinois tax. This credit, reported on Schedule CR of the Illinois return, is limited to the lesser of (a) the actual tax paid to the other state or (b) the amount of Illinois tax that would have been due on the same income. Because Illinois has a flat 4.95% tax rate, taxpayers earning income in a higher-tax state like California may not receive full relief, as Illinois will not credit them for taxes paid above its own rate. This can result in an effective tax burden exceeding Illinois’ standard rate.

California’s credit for taxes paid to another state is more restrictive. The credit is only available to California residents and applies solely to income taxed by another state. Unlike Illinois, California does not offer this credit to nonresidents. The credit is calculated based on the lower of the tax paid to the other state or the California tax liability on that income. If a California resident earns income in Illinois, where the tax rate is lower, the credit is limited to the Illinois tax paid, potentially leaving a portion of their income subject to additional California tax.