Is Indiana in Kentucky? Tax Rules for Living and Working Across Borders
Understand tax rules for living in one state and working in another, including reciprocity, filing requirements, and credits for taxes paid.
Living in one state while working in another can create confusion when it comes to taxes. Many people who live near the Indiana-Kentucky border commute daily for work, leading to questions about tax obligations in both states. Understanding these tax rules helps avoid unnecessary payments or filing mistakes.
Tax agreements, residency status, and available credits determine what you owe and where you need to file. Knowing these details ensures compliance with tax laws while preventing double taxation.
Geographic and Legal Separation
Indiana and Kentucky have separate tax laws, government structures, and residency definitions. The Ohio River serves as a physical boundary, but tax obligations are based on legal definitions rather than geography. Residency is determined by where an individual maintains a permanent home.
Indiana considers a resident to be someone with a permanent home in the state. Kentucky follows a similar approach but also factors in voter registration, vehicle registration, and state-issued identification. These determine where a person owes full-year tax obligations.
State tax rates differ. As of 2024, Indiana has a flat individual income tax rate of 3.15%, while Kentucky’s is 4.5%. Indiana counties impose additional income taxes ranging from 0.5% to 3.38%. Kentucky cities and counties may levy occupational taxes on wages earned within their jurisdictions, which are withheld from paychecks.
Nonresident State Return Requirements
Earning income in a state where you don’t live often requires filing a nonresident tax return. Indiana residents working in Kentucky, or vice versa, must report earnings to the state where the income was generated.
Kentucky requires nonresidents to file Form 740-NP if they have taxable income from Kentucky sources, including wages or business income. The state applies a 4.5% flat income tax rate. However, Kentucky’s local occupational taxes must be paid regardless of residency.
Indiana nonresidents earning income in the state must file Form IT-40PNR. Indiana’s county income taxes apply based on the taxpayer’s county of residence as of January 1 of the tax year, not where the income is earned. This means a Kentucky resident working in Indiana may owe county tax in their home state but not in Indiana.
Reciprocity Between the Two States
Indiana and Kentucky have a tax reciprocity agreement that simplifies income tax requirements for residents working across state lines. Under this agreement, residents only pay income tax to their home state, avoiding the need to file a nonresident return for wages earned in the other state.
Indiana residents working in Kentucky must file Form 42A809 with their Kentucky employer to exempt themselves from Kentucky state tax withholding. Kentucky residents employed in Indiana must submit Form WH-47 to their Indiana employer for the same purpose. Without these forms, employers will withhold taxes for the work state, requiring employees to file for a refund later.
Reciprocity applies only to wages and salaries, not self-employment earnings, rental income, or business profits, which remain taxable in the state where they originate. While state income taxes are covered, local occupational taxes in Kentucky and county income taxes in Indiana are not. These must still be paid, regardless of residency.
Special Filing Steps for Dual-Border Commuters
For individuals who live in one state and work in the other, ensuring the correct state tax is withheld throughout the year is essential. Employers may not always apply reciprocity agreements correctly, leading to incorrect withholdings. Reviewing pay stubs regularly can prevent unexpected tax bills or the need to file amended returns.
Remote workers face different tax considerations. If an Indiana resident works remotely for a Kentucky employer, or vice versa, tax obligations depend on where the work is physically performed. Unlike some states, Indiana and Kentucky do not impose “convenience of the employer” rules, meaning remote workers are taxed based on residency.
Those with additional income sources, such as freelance work or investments, may need to make quarterly estimated payments to avoid underpayment penalties.
Credits for Taxes Paid
Even with reciprocity, some individuals may owe taxes to both Indiana and Kentucky due to local tax policies or non-wage income. Both states offer credits to prevent double taxation, but the rules differ based on residency and the type of tax involved.
Indiana residents who pay Kentucky taxes on non-wage income, such as business profits or rental earnings, can claim a credit on their Indiana return using Schedule 6. This credit is limited to the lesser of the actual tax paid to Kentucky or the amount that would have been owed under Indiana’s tax rates. However, Indiana county income taxes are based on residency and are not eligible for credit, meaning an Indiana resident working in Kentucky may still owe county tax.
Kentucky residents who pay Indiana taxes on non-wage income can claim a credit on their Kentucky return using Schedule ITC. The credit ensures taxpayers do not pay more than they would have if the income had been earned entirely within Kentucky. However, Kentucky’s local occupational taxes are not eligible for credit, meaning a Kentucky resident working in an Indiana city with a local tax must still pay that amount.