After weeks or months of job seeking, you land your dream job — but it’s in a different state. The location of the job is close enough so that you can commute every day rather than move. However, you are still faced with the dilemma of where and how to pay state income taxes. Here’s what you should know if you live in one state but work in another.
Understanding State Residency
State residency is a key factor in determining tax obligations. Most states define residency based on the amount of time spent within their borders. Generally, if you spend a certain number of days within a state, you may be considered a resident for tax purposes. However, residency rules can vary significantly from state to state.
Domicile vs. Statutory Residency
Some states differentiate between domicile and statutory residency. Domicile typically refers to the place you consider your permanent home, while statutory residency is based on the number of days you spend in a state during the tax year, regardless of domicile. Understanding these distinctions is crucial for tax planning.
State-specific Rules
Each state has its own rules regarding residency and taxation. For example, some states, like California and New York, have strict guidelines for determining residency, while others, like Florida and Texas, have no state income tax, making residency less of a concern.
Do I Pay State Income Taxes Where I Live Or Work?
The easy rule is that you must pay nonresident income taxes for the state in which you work and resident income taxes for the state in which you live, while filing income tax returns for both states. However, this general rule has several exceptions. One exception occurs when one state does not impose income taxes. Another exception occurs when a reciprocal agreement exists between the two states.
States with No State Income Tax
As of 2023, there are currently nine states in the U.S. that have no state income tax:
- Alaska
- Florida
- Nevada
- South Dakota
- Tennessee
- Texas
- Washington
- Wyoming
New Hampshire taxes only dividend and interest income.
States With Reciprocal Tax Agreements
What if you live in Milwaukee but you commute every day by Amtrak to Chicago? It just so happens that Wisconsin and Illinois share what is known as a reciprocal tax agreement. Reciprocal agreements allow residents of one state to work in neighboring states without having to file nonresident state tax returns in the state where they work. As a result, your employer would deduct only Wisconsin state taxes from your paycheck, and none for Illinois. Likewise, if you live in Chicago but work in Wisconsin, your employer will only deduct Illinois resident state income taxes from your paycheck. In both instances, you would only be required to file one state income tax return.
States Without Reciprocal Tax Agreements
If you are unlucky enough to work across state lines in a state with no reciprocal agreement with your resident state, (for instance,Illinois andIndiana), then you will need to file income tax returns for both states. However, you should also be able to claim a credit on your resident state income tax return for the state income tax that you paid for the nonresident state. The result is that you actually pay taxes for one state, even though you must deal with the hassle of filing returns in both states.
For example, let’s say you are an Arizona resident and you received rental income from an investment property in Utah. These two states do not have tax reciprocity. So, you report this income to Utah and pay the appropriate tax. When you file your Arizona state tax return, you’ll need to pay taxes on the rental income, but you will receive a credit for the taxes paid to Utah.
It’s important to note that reciprocity is not automatic. You must file a request with your employer to deduct income taxes based on your state of residence rather than where you work. Unless you make a formal request with your employer, you will continue to be taxed by both states and you will continue to be obliged to file two state income tax returns.
FilingMulti-StateIncome Tax Returns
Many people are faced with the dilemma of working in one state and living in another, meaning they need to file a nonresident state tax return. People living and working in two different states often delegate the task of filing state income tax returns to atax preparationexpert, an accountant, or a tax attorney. Still, know that many online and home-based tax preparation software programs include state income tax forms with detailed instructions on how to file multi-state tax returns. If your tax situation is otherwise straightforward, you can save yourself a considerable amount of money by using a software program that includes both state and federal income tax forms and filing your own income tax returns.
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