10 Tax Tips for People Working and Living in Different States
If your morning commute takes you from kitchen to couch, consider it a win. Maybe it took years to convince your employer that you’d make an ideal telecommuter. Now you are enjoying the fruits of your labor, a perfect blend of working at home and traveling to consult with clients in other states. Plus, you get to skip roadway hassles and dive straight into your workday.
Or maybe you never planned to work from home, but the COVID-19 pandemic shut down the main office and turned everyone into remote workers. You might have moved back to your parents’ house temporarily during the pandemic or rented an Airbnb with some buddies in Montana to wait out the crisis.
Then, tax time arrives. Suddenly, you’re faced with paying taxes in your state of residence and the states in which you work. Or are you? The internet is full of questionable tax advice for people working in one state and living in another, including a few dubious suggestions that you’re pretty sure could land you in hot water.
To make matters more complicated, the rules and regulations covering personal income tax vary from state to state. If you commute across state lines to get the job done, it can have specific and surprising consequences on your personal income taxes. These 10 tax tips can help you navigate the way.
10: Understand Residency, Nonresidency and Your State Taxes
If you’re living and working in two different states, you’ll need a firm understanding of key tax-related definitions. The distinctions between residency and nonresidency — and, more importantly, how they affect your taxes — vary from state to state. You’ll want to investigate the tax rules and regulations that apply to each of the states in which you lived and worked during the tax year.
It may seem obvious, but it’s worth mentioning that the state in which you reside is considered your state of residency. In general, you’ll pay state taxes on all the personal income you earn in your home state (unless you live in a state without personal income taxation).
If you work in a state but don’t live there, you are considered a non-resident of that state. So, who gets to tax you? It’s a little complicated.
It used to be that both states might try to take a bite of the apple, but in 2015, the U.S. Supreme Court outlawed such double taxation, and barred two states from taxing the same earnings. That means that if you live in Maryland but actually earn your money and pay taxes on it in Pennsylvania, Maryland can’t tax you for that same income. Instead, the state has to issue a tax credit for the amount that you’ve paid to Pennsylvania [source: Wolf]. Essentially, the state where you actually work gets precedence, unless the two jurisdictions have an agreement to allow you to pay taxes where you live.
9: See If Reciprocity Applies
Sixteen states and the District of Columbia have reciprocity agreements with neighboring states, which means that if you work in D.C. but live in Virginia, you don’t have to pay taxes in D.C. or even file a return. All you’ve got to do is document your residency to your employer, so that he or she will withhold taxes for your home state, but not for the two states.
In addition to the District, the states with reciprocity agreements with neighboring states are New Jersey, Pennsylvania, Maryland, Virginia, West Virginia, Ohio, Kentucky, Illinois, Michigan, Wisconsin, Indiana, Iowa, Minnesota, North Dakota, Montana and Arizona.
In the remainder of the country, you may have to spend some time and money filing a nonresident state tax return in both places, but you can take a tax credit for whatever amount of tax you may owe in the state where you work.
Some states have an earned-dollar threshold that must be met; others have a time threshold. In Massachusetts, for example, nonresidents are required to file state taxes if the income they earn in the state exceeds $8,000 or reaches a certain portion of their overall income. In Kansas, nonresidents are subject to tax withholding from the first day they travel to the state for work [source: Massachusetts Department of Revenue].
8: Check to See If You’re Covered by the “First Day” Rule
A blast of chilled air finds its way into the jet bridge, offering a greeting as bracing as it is refreshing. You deplane and check emails on your smartphone while walking through the Denver International Airport. It may not look like you’re clocked in, but you are mentally preparing for a business meeting. And even though you don’t live in Colorado, today you’ll be part of its workforce — if only for about 24 hours.
You may not realize it right now, but you’ll soon join Coloradans in paying income tax, too. That’s because Colorado, like two dozen other states in America, operates under a “first day” rule. This means nonresident workers will owe Colorado state taxes even if their work there is temporary. Once you set foot on “first day” soil for work, you’ll pay the price come April 15.
In addition to Colorado, there are “first day” personal income tax regulations in Alabama, Arkansas, Connecticut, Delaware, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Rhode Island and Vermont. Illinois used to be on that list, but switched to a 30-day minimum for tax years starting after Dec. 31, 2020. If you travel for work, it’s a good idea to brush up on state tax code or consult a knowledgeable tax professional [sources: Mobile Workforce Coalition, Povich].
7: Understand the State Waiting Period
There are great variations among states when it comes to requiring nonresidents to pay taxes. In addition to the “first day” rule, some states have a waiting period. This waiting period allows nonresidents to earn income in the state for a specific period of time before subjecting that income to taxation.
For example, in some states, you can be a nonresident who works in-state for two to 60 days (it varies by state) before becoming liable for nonresident income tax. Alternatively, a handful of states — California, Idaho, Minnesota, Oklahoma, Oregon, and Wisconsin — have earned income thresholds instead of waiting periods. Georgia has a combination, in which you must have taxes withheld if you’ve worked for more than 23 days or else made $5,000 or 5 percent or more of your total income in Georgia [sources: Mobile Workforce Coalition, Povich].
Arizona and Hawaii don’t tax income from out-of-state sources if you’re a nonresident [sources: Arizona Dept. of Revenue, Hawaii Dept. of Taxation]. There are other states in which personal income tax is not withheld for residents or nonresidents. Despite this lack of income tax, you may still need to file a tax return in those states if you live or temporarily work there.
6: Working in a Tax-free State Is Still Taxing
There are seven U.S. states that do not withhold income tax: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming [source: Mobile Workforce Coalition]. Two other states — New Hampshire and Tennessee — tax interest and dividend income, but not earnings.
Still that doesn’t mean you won’t pay taxes on the income you earn while working in these nine states. If you work in one or more of these income tax-free states, but live in a state that does withhold income tax, you’ll still need to pay taxes on the money you earned in the tax-free state. You’ll claim these earnings on the tax return you file in your resident state.
For example, Lois lives in New Mexico but earned an income of $25,000 while working in Texas. Lois won’t owe any state income taxes in Texas, because Texas is one of the nine states in the U.S. that doesn’t require its workers to pay personal income tax. However, because Lois lives in New Mexico — and New Mexico is a state that withholds personal income tax, she will need to report her Texas income on the taxes she files in New Mexico.
5: State Income Tax Isn’t the Same as Federal
When it comes to paying personal income tax, it’s rarely as simple as “one and done.” Especially for people who live in one state and work in another. Don’t fall into the trap of thinking that if you file federal taxes, you’ve covered all the bases. State income taxes follow entirely different rules and regulations. What’s more, these rules and regulations vary by state. People who live in one state and work in another could find themselves filing tax returns in multiple states. In fact, there are accounts of road warriors who work in as many as 20 or 30 states, each with different rules for reporting income for taxes.
This presents a significant record-keeping problem not only for workers, but also for the companies that employ them. As a result, some multistate companies, as well as tax professionals, are turning to software developers for programs that can track interstate taxation among employees. However, the complexities — and ever-changing nature of the tax code — make it a monumental task.
For example, some regulations tax nonresident workers who enter the state for one day, which poses issues for workers who might do business on a smartphone during a lengthy layover or attend a conference at which work is discussed.
5: Know Where You Don’t Have to Pay Taxes
The location of your employer’s corporate headquarters doesn’t have any effect on where you pay taxes, if you work at a branch office in another state. For example, you might live in Connecticut and work for a California-based company, but if your office is in Connecticut, that’s the state that gets to withhold your taxes and require you to file a return, because you actually perform your job duties in Connecticut instead of California.
The only complication to this is if your company inadvertently withholds taxes in its home state. In that case, here’s some bad news – you may have to file a tax return there in order to get a refund.
A different sort of complication arises if you work in the U.S. capital. The District of Columbia allows residents of any U.S. state an exemption from D.C. income taxes, although they still must file in their home states. Other multistate regions aren’t quite as accommodating. In fact, some would even argue that some states are overtaxing workers. Keep reading to find out more.
4: Be Wary of the New York-Connecticut Trap
As we previously explained, there are many states with reciprocity agreements that save taxpayers from having to file tax returns in two places. Unfortunately, though, not all neighboring states have such agreements.
If you live in Connecticut, for example, but work in New York, you’ll have to file both a nonresident tax return in New York and a resident tax return in Connecticut. You’ll be allowed to claim a tax credit for income tax paid in New York on work you do there by filing a Form CT 1040, Schedule 2, and attaching your New York return, according to the state of Connecticut’s official online portal [source: Ct.gov].
Another problem is that the credit amounts to the lesser of the tax paid to New York or the tax that Connecticut would impose on the wages, meaning that if you earned a lot of money in New York, you still owe taxes in Connecticut even with the credit. If the amount owed is $1,000 or more, you’ll also be required to file quarterly estimated tax payments to Connecticut, due April 15, June 15, September 15 and January 15. See, we warned you this was going to get complicated [source: Ct.gov].
3: File in the Right Order
Most people filing a state tax return only need to do so in a single state. For those who live in one state and work in another, the process is a bit more complicated.
There’s a specific order in which you’ll need to file multiple state tax returns. First, you’ll file in the nonresident state or states in which you’ve earned income. For example, if you were not a resident of Missouri, but worked there for three months as a contractor, you’ll need to submit your tax return to Missouri before submitting one to your home state. Keep in mind, you’ll only need to do a tax return in your home state if it levies income tax against its residents.
The reason for filing in the nonresident state first is to determine the amount of credit or deduction you can claim for taxes already paid in other states before completing the tax return from your resident or “home” state. Even if you don’t owe taxes in your home state — perhaps your only income for the tax year was earned in another state — you may still need to file a state tax return to get a refund [source: Caplinger].
2: Be Aware of Telecommuting Complications
For many years, Sarah worked and lived in New Mexico, the same state in which her employer was located. Then she and her family moved to Colorado, where she continued to work for her employer.
So, what’s the problem? The solution is simple enough, right? Sarah will need to file taxes in the state in which she lives and works: Colorado. Most states have a physical presence rule, and Colorado is one of them. In short, this means Sarah’s wages will be taxed where the work is done.
If Sarah lived in one of the five states that does not follow the physical presence rule (Alaska, Oregon, Montana, New Hampshire and Delaware), she’d have different rules to follow. The wages she earned would be taxable in the state where she lives and the state where her employer is located.
There are a couple of exemptions, including an exemption for work that could only be performed out of state. An employee who works in sales and covers an out-of-state sales territory is a good example of this exemption [sources: Schapiro, Avalara].
A few states have also issued exemptions for workers affected by COVID-19 “stay at home” orders. Georgia, for example, has offered tax protections to workers who temporarily relocated to Georgia and telecommuted to work. They do not have to pay Georgia income tax for the time that they were working in Georgia under an official stay at home order or during quarantine from exposure to COVID-19 [source: Georgia Dept. of Revenue].
Most states have not changed their income tax rules in response to the pandemic, so check with your state department of revenue for more information. (The law firm Hodgson Russ has provided a chart showing the tax implications related to telecommuting during the COVID-19 crisis for all 50 states and the District of Columbia. Many states, according to their chart, have so far not offered any specific guidance.)
1: There May Be Corporate Tax Implications
Telecommuting from another state may not pose a problem for you, but it could for your employer. When a telecommuter works for an employer in another state, the employer establishes “nexus,” or a business presence, in the telecommuter’s state. And this can have tax consequences. The employer may need to file a corporate income tax return in the state in which their employee is working.
In general, these corporate tax implications have little to do with your personal income tax. Although you could get some blowback from an employer who is reluctant to spread its corporate reach to another state for just one employee, there’s not much to worry about from an individual standpoint, aside from being phased out. The truth is, the location of your employer’s corporate offices has nothing to do with your tax responsibility. You’ll pay taxes in the state or states where you work, as long as they tax personal income.
In most cases, states are giving corporations a pass for employees who relocated due to the COVID-19 pandemic. In other words, state tax authorities are not requiring corporations to establish “nexus” in their state if an employee relocates there temporarily due to the pandemic.
Again, if your employer mistakenly withholds tax in the state in which it is headquartered, you’ll have to voluntarily file a return in that state. That way, you can get any refund you are due.