If you live in one state and work in another, taxes can be complicated. And the rules can vary significantly from state to state.
Some states with a lot of commuters have reciprocity agreements, so you’re only taxed by your state of residence even if you cross state lines to go to work. Other states tax nonresidents who physically work within their borders but they usually receive a tax credit from their home state to avoid double taxation. And a few states make the tax rules especially complicated for remote workers.
Here’s what you need to know about taxes if you work in a different state from where you live.
States With Reciprocity
If the state in which you work has a reciprocity agreement with the state in which you live, the procedure is usually simple.
“You won’t be taxed on where the income is earned; you’ll just be taxed on where you live,” Richard Auxier, senior policy associate for the Tax Policy Center, says.
You can ask your employer to have income taxes withheld for the state where you live, and you generally file a state income tax return like you would if you worked in your home state.
Fifteen states and the District of Columbia have reciprocity agreements — some states have an agreement with just one other state, while others have agreements with as many as six or seven states, Jared Walczak, vice president of state projects for the Tax Foundation, says.
The reciprocity agreements are generally with nearby states where a lot of commuters live. For example, the District of Columbia, Maryland and Virginia all have reciprocity.
“The District of Columbia represents a unique case because D.C. is precluded from taxing nonresidents regardless of where they earn income,” Walczak says. “Virginia and Maryland have responded to this by adopting commuter agreements which exempt each other’s residents from tax but also ensure that they are able to tax their residents when they work in D.C.”
Kentucky has the tax reciprocity agreements with the most states; Illinois, Indiana, Michigan, Ohio, Virginia, West Virginia and Wisconsin. A few states have reciprocity agreements only with one other. For example, Iowa offers reciprocity with Illinois, Montana with North Dakota and New Jersey with Pennsylvania.
“Reciprocity agreements benefit taxpayers by dramatically reducing tax filing complexity,” Walczak says.
“They are particularly beneficial to hybrid workers, who may work from home several days a week and in an office across state lines on others. Reciprocity agreements eliminate the need to track which days were worked where for tax purposes, and they let each state focus on taxing their own residents,” he adds.
For a list of states with reciprocity and more information about the rules, see Walczak’s Tax Foundation article.
“There have been few or no changes to reciprocity agreements in a very long time,” Tim Bjur, attorney and senior content management analyst for Wolters Kluwer Tax & Accounting, says.
You need to let your employer know where you live — and update the HR department if you move — to make sure your taxes are withheld for the appropriate state. You can look on your W-2 form to see which state’s taxes have been withheld from your income.
States Without Reciprocity
Not all states offer reciprocity, even if they have a lot of commuters traveling across state lines. If the state where you work doesn’t have reciprocity with the state where you live, you may need to take extra steps when you file your income tax return.
[Read: How to File Taxes.]
“Generally speaking, income is taxed where you earn it,” Auxier says.
You may have taxes withheld from your pay for the state where you work, and you may need to file a nonresident income tax return with that state as well as a resident return in your home state.
In most cases, you get a credit for the taxes you paid to the state where you work, which reduces your income tax liability in your state of residence.
“If your state has an income tax, you’re going to have to file that income tax return and you’ll typically get a credit” for taxes you paid to another state, Auxier says. “You generally are not going to be double taxed.”
Since states have different income tax rates, this credit may not be for the full amount paid to the other state if your state’s income tax rate is lower.
Walczak gives an example of living in a state with a 5% income tax rate but working in a state with a 7% rate.
If you earned $60,000 in the other state, it would be taxed at 7% ($4,200), and your state would offer a credit reducing your home-state tax liability by $3,000 (5% of your income). But if you lived in the higher-tax state and worked in the one with the lower rate, you would pay $3,000 to the state where you work and an extra $1,200 to your home state. Either way, the total tax liability is the same but the allocation to each state varies, he says.
“Almost all states allow a credit for the other state’s tax,” Mary Kay Foss, a certified public accountant in Walnut Creek, California, says.
For example, Foss explains what usually happens if someone lives in California and pays 9.3% tax but works in another state with a 6% tax.
“The 6% tax will be owed to the other state and California will allow a credit based on the lower of what was actually paid to that state or what California charges on that state income. In this example, the 9.3% California tax would be offset by a credit for the 6% paid to the other state,” she says.
Taxes are generally based on where you physically do your job — the state where the income is earned. That means fully remote workers usually pay taxes to the state where they live and work, regardless of where the company is headquartered.
A Few States Have More Complicated Rules
The rules are more complicated in a few states.
“New York and a handful of other states have so-called ‘convenience rules,'” Walczak says.
“They source income to that state if your office is located there, even if you actually work elsewhere. For many remote workers who don’t have an office but whose employer is located in New York or another convenience rule state, this can result in double taxation,” he adds.
Under the convenience rule an employee is treated as if they work in their employer’s state if their work is performed elsewhere for “the convenience of the employer,” Walczak says. This can include remote work as well.
Connecticut, Delaware, Nebraska, New York and Pennsylvania currently have convenience rules, he says.
“Many people are required to file and remit taxes to multiple jurisdictions, but typically they are able to claim a credit against tax liability in their home state for taxes paid on income earned elsewhere,” Walczak says.
“This credit system can fall apart under convenience rules, since your home state and the convenience rule state may disagree on where you earned the income,” he adds.
According to Walczak, your state of residence might conclude that if you lived and worked within its borders that’s where you should pay income tax, and it may not offer you a credit when another state chooses to tax you on the same income.
How to Avoid Complications
Here are four steps you can take to help avoid complications if you live and work in two different states:
1. Let your employer’s HR department know which state you live in and ask about the rules. If the two states have reciprocity, your employer should be able to withhold taxes from your pay for your state of residence.
2. If you move to a different state, be sure to let your employer know so it can adjust your state tax withholding. Auxier says sometimes people forget to ask their employers to change their state withholdings and they have to file nonresident returns to get back the money from their former states of residence.
This doesn’t affect the amount you owe — you won’t have any tax liability with the old state if you didn’t live or work there during the tax year — but you may have to pay a big bill when you file your return with your current state of residence because no money was withheld for that state. Meanwhile, you may need to wait for a while to get the money back as a refund from your former state.
“If you didn’t update your withholding, you can file a nonresident return and get the money back because you didn’t owe any taxes to that state, but you are going to owe tax to the place where you currently live, and you’re going to have to get them the money,” Auxier says.
3. If the states don’t have reciprocity, find out about your obligations to the state where you work. You’ll usually need to file a nonresident tax return for the state where you work and a resident tax return for the state where you live. Also, find out how your state of residence calculates any credit for taxes paid on out-of-state work. You can find out more by contacting both departments of revenue.
“If you worked in multiple states, you could owe income taxes in each,” Walczak says. “Some states require taxpayers to file after a single day of work, while others have thresholds as much as a month, or thresholds based on income earned. Those who may owe taxes in multiple states would be well advised to consult a tax preparer if uncertain about their complications.” It helps to work with a CPA who’s familiar with both states’ rules.
4. Keep records of where you worked and when. If you occasionally go to the employer’s office in another state but generally work in your state of residence, you may not have to pay taxes to the other state if you work there fewer than a certain number of days each year. Walczak says states are beginning to raise filing and withholding thresholds and not require people to file a return in a state where they worked only for a short amount of time.
“Taxpayers may need to be able to document when they worked in which states and should recognize that working from multiple states can yield additional tax complexity,” he says. “If a taxpayer is unfortunate enough to work remotely for a company based in a convenience rule state, they may face double taxation.”
[READ: What Really Happens During an IRS Tax Audit]
Special Rules for Military
The rules for active duty military members and their spouses are different.
According to Curt Sheldon, certified financial planner and enrolled agent in Alexandria, Virginia, who served for 27 years as a fighter pilot in the U.S. Air Force, “Under the Servicemembers’ Civil Relief Act, a service member does not become a resident of a state for income tax purposes if his or her presence in the state is due to military orders.”
Service members can maintain their legal residency in the state where they lived when they first joined the military, or they can establish residency in another state while they are stationed there.
“Many service members elect to establish residency in a state without income tax if they are stationed there,” Sheldon says. For example, some service members establish residency in Florida or Texas while stationed at one of the many bases in those income-tax-free states, and they can maintain residency there as long as they’re on active duty, even after they have to move.
Find out more from your state department of revenue about the rules for establishing residency in a state where you are stationed. You usually must register to vote, register your car, get your driver’s license in that state and plan to return there after you leave the service.
The Military Spouses Residency Relief Act amended the SCRA in 2009 and allows spouses of active duty service members to maintain the same state of residency as the military spouse.
But everything changes when they leave the military. At that point, the service member and spouse will be subject to the tax laws of the state where they are located, rather than the domicile they established while in the service.
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How to Handle Taxes When You Live and Work in a Different State originally appeared on usnews.com
