Taxes When Working Out of State: A How-To for Filers
Navigate the complexities of state income taxes when your work crosses state lines. Understand your obligations and ensure accurate, compliant filings.
Working across state lines introduces complexities to personal income taxes. Each state has its own rules for taxing income, making tax obligations challenging. Understanding how states define residency, source income, and offer relief from double taxation is important for accurate filing.
Understanding Residency and Domicile for Tax Purposes
Taxation begins with understanding your residency and domicile status. Domicile refers to your permanent home, the place you intend to return to after any temporary absences. An individual has only one domicile. States consider various factors when determining domicile, such as:
- Where you vote
- Where you hold a driver’s license
- Where you register vehicles
- Where you own property
- Where you spend most of your time
- Where you maintain bank accounts
- Where you have family ties
Residency, on the other hand, is a legal concept that drives income tax assessment. While you can have only one domicile, it is possible to be a resident of more than one state for tax. Some states also employ a “statutory residency” test, based on the number of days spent in the state, such as 183 days, and maintaining a permanent abode there.
If you are domiciled in a state, that state taxes all of your income, regardless of where it was earned. Correctly identifying your domicile and residency status is an important step in navigating multi-state tax obligations.
How Income is Taxed Across State Lines
When you earn income across state lines, the concept of “income sourcing” comes into play. Sourcing rules determine which state has the right to tax specific income. For wages, income is sourced to the state where the work is physically performed. This means if you work in a state other than your resident state, the work state may tax the income earned within its borders.
For self-employment or business income, the sourcing rules can be more nuanced. Income is sourced to where the business activities are conducted or services are rendered. For example, a self-employed consultant living in one state but providing services to clients in another state may find their income sourced to the client’s state, even if the work is performed remotely. Some states may even consider income from clients located within their borders as sourced to that state, regardless of where the self-employed individual physically performs the work.
This distinction between residency and sourcing is important. Even if you are a non-resident of a state, that state can still tax income that is sourced within its borders. This applies to scenarios like temporary work assignments or remote work for an out-of-state employer. Employers are required to withhold tax from compensation earned in a state to approximate the employee’s in-state personal income tax liability.
Avoiding Double Taxation
To prevent taxpayers from being taxed twice on the same income by different states, states offer a “credit for taxes paid to another state”. This credit is granted by your resident state for income taxes you paid to a non-resident work state. The purpose is to reduce your overall tax liability when both your resident state and a non-resident state have a claim on the same income.
Calculating this credit involves determining the amount of income taxed by both states and the actual tax paid to the non-resident state. The credit is limited to the amount of tax your resident state would have imposed on that specific income. For instance, if you had $1,000 withheld by a non-resident state but received a $250 refund, the amount of tax paid for credit purposes would be $750.
When claiming this credit, you need to complete your non-resident state tax return first. This allows you to accurately determine the tax liability to the non-resident state. Attaching a copy of the non-resident return to your resident state return is recommended for verification.
Special State Rules and Agreements
Specific state rules and agreements can impact how multi-state income is taxed. One common arrangement is a “reciprocal agreement” between states. These agreements allow residents of one state to work in a neighboring state without having to pay income tax to the work state. Instead, individuals only file and pay income taxes to their home state.
If a reciprocal agreement is in place, employees need to file an exemption form with their employer to prevent withholding by the work state. There are reciprocal agreements across many states and the District of Columbia. Some states, like Indiana, have unilateral agreements, meaning they will extend reciprocity to any state that offers similar treatment to their residents.
Another specific rule is the “convenience of the employer rule,” which applies in some states, including New York, Pennsylvania, Delaware, and Nebraska. Under this rule, if a non-resident works remotely for an employer located in one of these states, the income may still be sourced to the employer’s state, even if the work is performed elsewhere, if the remote work is for the employee’s convenience rather than the employer’s necessity. This rule can lead to double taxation if the employee’s home state does not provide a credit for taxes paid to the employer’s state.
Filing Your Tax Returns in Multiple States
Once you understand your residency, how income is sourced, and any special state rules that apply, the next step is filing your tax returns. If you earned income in a state where you are not a resident and that state taxes income, you will need to file a non-resident return in that state. Following this, you will file a resident return in your home state.
The order is to prepare and file the non-resident state return first. This is because the information from the non-resident return, particularly the tax paid to that state, is needed to calculate the credit for taxes paid to another state on your resident return. It is important to ensure your W-2 forms accurately reflect state withholding for each state you worked in. If there are discrepancies, contacting your payroll department for clarification or a corrected W-2 is advisable.
State tax filing deadlines align with the federal April 15th deadline, though some states may have slightly different dates, such as May 1st or May 15th. Many states offer automatic extensions to file, until October 15th, but these extensions only apply to filing, not to paying any taxes owed. Payments are still due by the original April 15th deadline to avoid penalties and interest. While tax software can assist in navigating multi-state filings, seeking advice from a tax professional is beneficial for complex situations.