The number of people working remotely has steadily increased over the last few years. As working remotely just started to become normalized, the worldwide coronavirus pandemic hit. Suddenly there were millions of Americans working from home or moving.
It’s estimated that as many as 42% of Americans worked remotely in 2020, and nearly nine million people relocated. These sudden and massive shifts have resulted in severe complications, especially for people living in one state and working in another.
Filing your tax return under normal circumstances can be pretty confusing. It will only get more complicated if you work in one state and live in another. The easiest solution is to talk with a tax professional. They can help guide you through the tax process and make sure you pay the right amount of taxes to the right places.
In Which States Will You Owe Taxes?
State taxes are a bit complicated and can vary significantly. First of all, nine states don’t even have an income tax. If you live in Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, or Washington, you won’t be taxed.
Living in any of the other 41 states will mean filing and paying state income taxes. The confusing part is whether or not you will have to pay taxes in the state where your employer is located.
One of the most critical factors is whether or not the state you live in has a reciprocal agreement with the state you work in.
What States Have Reciprocal Agreements?
A reciprocal tax agreement between two states means that the state you work in won’t withhold state taxes from your paycheck. You will only need to file and pay taxes based on the state that you live in.
Not all states have a reciprocity agreement. Ultimately, it’s your responsibility to request that your employer not withhold state taxes if you live in another state.
These are the states that have a reciprocity agreement with each other:
- Arizona has an agreement with California, Indiana, Oregon, and Virginia. You won’t need to pay AZ state taxes if you work there, but live in CA, IN, OR, or VA.
- Illinois has an agreement with Iowa, Kentucky, Michigan, and Wisconsin. You won’t need to pay IL state taxes if you work there but live in IA, KY, MI, or WI.
- Indiana has an agreement with Kentucky, Michigan, Ohio, Pennsylvania, and Wisconsin. You won’t need to pay IN state taxes if you work there, but live in KY, MI, OH, PA, or WI.
- Iowa has an agreement with Illinois. You won’t need to pay IA state taxes if you work there but live in IL.
- Kentucky has an agreement with Illinois, Indiana, Michigan, Ohio, Virginia, West Virginia, and Wisconsin. You won’t have to pay KY state taxes if you work there, but live in IL, IN, MI, OH, VA, WV, or WI.
- Maryland has an agreement with Pennsylvania, Virginia, and West Virginia. You won’t need to pay MD state taxes if you work there but live in PA, VA, or WV.
- Michigan has an agreement with Illinois, Indiana, Kentucky, Minnesota, Ohio, and Wisconsin. You won’t need to pay MI state taxes if you work there, but live in IL, IN, KY, MN, OH, or WI.
- Minnesota has an agreement with Michigan and North Dakota. You won’t need to pay MN state taxes if you work there but live in MI or ND.
- Montana has an agreement with North Dakota. You won’t need to pay MT state taxes if you work there but live in ND.
- New Jersey has an agreement with Pennsylvania. You won’t need to pay NJ state taxes if you work there but live in PA.
- North Dakota has an agreement with Minnesota and Montana. You won’t need to pay ND state taxes if you work there but live in MN or MT.
- Ohio has an agreement with Indiana, Kentucky, Michigan, Pennsylvania, and West Virginia. You won’t need to pay OH state taxes if you work there but live in IN, KY, MI, PA, or WV.
- Pennsylvania has an agreement with Indiana, Maryland, New Jersey, Ohio, Virginia, and West Virginia. You won’t need to pay PA state taxes if you work there but live in IN, MD, NJ, OH, VA, or WV.
- Virginia has an agreement with Kentucky, Maryland, Pennsylvania, and West Virginia. You won’t need to pay VA state taxes if you work there but live in KY, MD, PA, or WV.
- West Virginia has an agreement with Kentucky, Maryland, Ohio, Pennsylvania, and Virginia. You won’t need to pay WV state taxes if you work there, but live in KY, MD, OH, PA, or VA.
- Wisconsin has an agreement with Illinois, Indiana, Kentucky, and Michigan. You won’t need to pay WI state taxes if you work there, but live in IL, IN, KY, or MI.
Can You Be Taxed By Two States?
It can get a little bit tricky if you live or work in states that charge income taxes and don’t have reciprocal agreements. You should probably consider talking with a tax professional or accountant as you’ll probably have to fill out and file two different state tax returns.
The first state tax return you should file will be the one for the state you work in. You most likely have had income taxes being withheld by the state that you work in. You should fill out the information for that return first.
The tax return for the state you work in will include the total amount of state taxes withheld. Every state allows their resident to claim a tax credit based on the total taxes they paid out to other states. When you fill out your state tax return for the state you live in, you can use this credit to cover your state tax obligation.
There is a potential issue with filing your taxes this way. The state you live in may have different tax rates than the one you work in. You could still end up having to pay taxes if your tax credit doesn’t cover your state tax obligation. On the other hand, you could be due credit if your residential state rates are lower.
What Do You Do If You Move During the Year?
You will need to file two state returns if you permanently moved to another state and both states have an income tax. Each state has its own rules for determining residency, so you would need to read up on the laws in your state.
In most cases, you’ll be allowed to divide your total income between the two states. It’s against federal law for states to tax the same income twice. This way, you will only pay state income taxes based on where you were living at the time.
What Happens If You’re Self Employed?
Most of these examples rely on your employer withholding state taxes for you. If you are self-employed or a freelance worker, you won’t have this option.
Taxes are much easier for employees with W-2 tax status. Your employer will withhold money to apply to your state and federal tax obligations. As a freelance employee, it will be up to you to make these payments.
In most cases, you’ll need to establish a limited liability company (LLC) to work as a freelancer. Your state tax obligation will be based on the state that your LLC is registered in.
Can You File Jointly If Your Spouse Works in a Different State?
You can still file a joint return if you and your spouse work in different states. You would have to report your income from the state you worked in and report your income from the state where they worked.
You would list both incomes on your residential return. It’s on your residential returns that you will determine whether you need to pay additional state taxes or are due for a refund.
There is the option of filing jointly on your federal returns and separately on your state returns. While this is perfectly legal, it will probably be difficult to file using tax preparation software.
It might be worth talking with an accountant to make sure that you are paying your tax obligations and receiving the benefits of a joint filing.
There are a lot of obscure rules and laws involved with paying your taxes. While federal tax laws apply to everyone, each state has its own specific guidelines.
If you are a W-2 worker, your employer will withhold your state and federal taxes. Those taxes will go toward the state that you work in. Instead of paying taxes twice, you’ll have to include this information on your residential state return. You should receive a tax credit from your employment state that will cover the tax obligation of your residential state.
It might be best to talk with a tax professional to avoid making mistakes. The experts at Coast One Financial Group can help to get your taxes in order and prevent you from getting into trouble with the IRS.