Dealing with Multiple State Tax Returns
By Joseph Smith, EA, contributor
The average traveler works in more than one state each year. This usually requires a tax return to be filed in every state worked in including the home state. This is not the easiest task and taxpayers make frequent errors coordinating multiple state tax returns.
The Basics.
Each state return cannot be prepared in a vacuum as the results on one can be dependent on the other. Two basic principles are at work here. First, your home state will tax all income earned everywhere regardless of source. The fact that the income was not earned in the home state is irrelevant. At the same time, the work state will tax the income earned there. At first glance, this sounds like double taxation but this is not the case. To relieve the potential doubling up on the tax, the home state will allow a credit for the amount of taxes paid to work state. This credit is based on the formula that the home state uses to determine its own tax on the same income.
Illustration.
Suppose my home state is Nebraska and I take an assignment in Arizona. Also suppose for simplification, that Nebraska has a 5% tax rate and Arizona a 2% rate. All the income earned in Arizona will be taxed at 2%; however, when I file my Nebraska tax return, I will include the income earned in Arizona and pay the Nebraska rate on the Arizona income. That rate is reduced by the amount of tax that I paid Arizona leaving a gap of 3% which I must make up in an additional payment or through an amount I otherwise would be refunded. By contrast, if I was an Arizona resident working in Nebraska, the 5% rate that I paid to Nebraska would wash out the 2% that I would otherwise pay to Arizona on the same income. The end result is that I pay the higher of the two tax rates either completely to one state, or allocated between the two.
What about states that do not have an income tax?
The following states and jurisdictions do not have an income tax: Alaska, Washington, Wyoming, Nevada, South Dakota, Tennessee, Texas, Florida, New Hampshire, USVI, and the District of Columbia (for nonresidents). If I am a resident of any of these states or the USVI, I am not exempt from paying state taxes in the states that I work. States that do not have an income tax are not exempted; they simply have a 0% rate. Conversely, if I am from a state with an income tax, I will pay my home state tax rate on all the income earned in a state without an income tax. This last point is very important. Unless the employer withholds home state tax payments for work in a state without an income tax, the individual will have a considerable amount due on the home state tax return they subsequently file. If the employer cannot withhold for the home state, the traveler may need to make estimated payments during the year. This also holds true when the home state tax rate is significantly higher than the one in the work state.
There are exceptions to these rules, but they will require entirely separate articles which we will present in the coming months.
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