Living and Working in Different States Can Be a Tax Headache
Living in one state and working in another can trigger a number of tax issues. Here are several things to keep in mind if you and/or your spouse are in this situation.
Lately, we've seen a significant increase in the number of people changing jobs compared to past years. Some media outlets have named it the "Great Resignation." In many cases, people are crossing state lines and getting new jobs a different state than where they live. But doing this can also bring up tax issues that can be quite complicated. For instance, if I live in one state and work in another, which state income tax return should I file? Do I need to pay taxes for two states? Who withholds what? Let's try to answer these questions.
The question of where you're deemed to be a resident is an important one in determining which state will tax your income or how your employer will withhold taxes from your paycheck. For residents of a state, all income from sources inside and outside that state can be taxed by the state. When it comes to nonresidents, however, states have less power to tax. A state can only tax a nonresident on income generated within its borders, such as wages from a job in the state. But that also means you'll typically have state taxes withheld from your pay by the state where you work.
So, let's discuss what makes someone a resident of a state. You're generally deemed to be a resident of the state in which your primary home is located, assuming you've spent more than half of the year in that state.
But there are some exceptions to this general rule. For example, if someone has two houses in two different states, those states can look at other things to determine your state of residence, including where you vote, where you have a driver's license, and where your personal and professional links are found.
Additionally, some states also have a "183-day rule" that basically says if you're in the state for more than 183 days, you could be deemed a "statutory resident." This would make you liable for taxes as a resident in that state.
Convenience of the Employer Test
A handful of states apply a "convenience of the employer" test that can result in your wages being taxed by the state where your employer is located instead of the state where you live, even if you never set foot in the state where the employer is based. This affects people who telecommute for companies that are in a different state, which is happening more during the pandemic.
Under the "convenience of the employer" test, if an employer requires the employee to work in another state (employer's convenience), then taxes and withholding are based on the location where the work is performed. If, however, the employee chooses to work in another location (employee's convenience), then taxes and withholding are based on where the employer is located.
State Tax Returns
Let's move on to whether you'll need to file a state tax return where you reside and/or work. Generally, if you're a resident of the state in which you work, you'll just file one state tax return at the end of the year.
But what happens if you aren't a resident of the state in which you work? This often means filing multiple state tax returns and possibly dealing with double taxation issues (which we will discuss below). The tax return for the state where you work will be a nonresident return. In this return, you list only the income earned and taxes paid in that state. The other return will be a resident return for the state where you reside.
One exception to this rule is when you live or work in a state where there isn't a state income tax. So, if you live or work in Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, or Wyoming you won't need to file a state income tax return for that state. (Note that I'm not including New Hampshire in the list even though it doesn't have a state income tax because it still requires a state return if you have dividends or interest income during the year.)
Another exception to the rules requiring people to file a tax return for the state where they work involves what is called a reciprocity agreement. These agreements, which are made between states, allow residents to work out-of-state yet only file a state tax return for the state in which they reside. Moreover, under a reciprocity agreement, you'll only be subject to income tax withholding for the state in which you reside.
Keep in mind that the protections of a reciprocity agreement aren't automatic. In order to properly take advantage of the agreement, you must tell your employer to withhold taxes based on your state of residence rather than the state where you work. If you don't do this, you'll continue to be taxed by both states and forced to fill out two state tax returns.
Be careful if you are moving while involved in a reciprocity agreement. If you are permanently moving to a state in which there is no reciprocity agreement with the state where you work, you will lose all benefits of the agreement. In this situation, you would need to ask your employer to withhold income tax in the state where you work and the state where you reside.
Currently, 16 states and the District of Columbia have state tax reciprocity agreements. Please check with the state tax agency where you live to find out if you're in one of them.
If you're required to file multiple state tax returns because you live in one state and work in another, does that mean you'll pay taxes two separate times on the same income? No.
After you fill out a state tax return for the state where you work, you'll file a second tax return for the state where you reside. On this return, you'll report how much your tax liability was on the first state tax return. All states allow their residents to claim a tax credit based on the taxes paid to other states. Note, however, that there isn't any guarantee that the state tax credit will always equal what you paid in taxes to the state where you work.
For those who pay estimated taxes, you'll need to make estimated tax payments to each state based on your expect income, deductions, and credits. Therefore, it's important to talk to a tax professional when filing out estimate tax forms.
Moving to Another State
What if you live and work in one state for part of the year, and then pack your bags and move to another state to take another job during the same tax year? In this situation, you're technically a resident of two states during the year. This means that you'll need to file two separate state tax returns for the year.
Depending on the state, you may be able to pay taxes as a part-year residence. Most states allow for a person to be a part-time resident for tax purposes if they move into the state during the year with the intent of becoming a resident or leave the state with the intent to reside elsewhere. By doing this, you can divide your income between the two states and not pay tax on the same income two separate times.
Again, this will heavily depend on whether the state at issue has a part-year residence status. Check with the state's tax agency to learn these rules.
What About My Spouse?
What if your spouse has a job in a different state? Assuming both states at issue have a state income tax and there's a reciprocity agreement between them, both you and your spouse will need to file a state tax return for the state where you reside. If your spouse works in another state that doesn't have a reciprocity agreement with the state where you live, he or she will need to file a separate return as a nonresident in the state where he or she is employed.