How State Income Taxes Work When You Live Or Work In Multiple States

February 06, 2019

For people who travel a lot for work or live close to a state line, state income tax withholding and filing is often a bit confusing. Maybe you earned income in more than one state during the year or in some cases, you may not even live in the state where your employer has an office.

We get a lot of questions about this stuff and while we’re not tax professionals nor is this intended to be tax advice, I’m hoping to provide some clarity around how it all works. There are several moving pieces, and everyone’s situation can be a bit different, so consider consulting with a tax professional if you’re unsure so that you don’t end up with any unwanted tax surprises.

How multi-state income taxes work

The default rule for determining state income tax withholding is to withhold tax for the state in which you actually provided a service – you pay first to where you work, then possibly also to where you live. It gets a bit more complicated when you earn income in more than one state or if you earn the income in a state but live in another. Other withholding rules come into play.

Where are you actually a resident?

Typically, the state where you’re considered a resident governs how you’ll ultimately be taxed on your income. States have their own rules around how to treat income you earn there as either:

1. A resident, who had income from another state, OR
2. A non-resident who had income from within that state.

Check the rules of your state here.

TIP: A common misconception is that if your employer’s home office is in New York for instance, that your employer has to withhold New York state income tax from your pay, even if you did not earn any income in New York for the year. That’s actually not true – I live in Florida (where there are no income taxes!) and Financial Finesse is headquartered in California – thankfully I don’t have to pay California taxes.

If however, your employer’s home office is located in the state where you’re considered a resident, your employer would have to adhere to that state’s laws. In addition to withholding income tax for other states where you earned income, your employer may have to withhold that state’s income tax from your pay though you did not earn income there. It depends on what the state’s law says.

Does your home state have a reciprocal agreement with any of the states you worked in?

A reciprocal agreement, also called reciprocity, is an agreement between two states that allows residents of one state to request exemption from tax withholding in the other (reciprocal) state. So for example, if you’re a resident of Michigan who works in Ohio, your employer only has to withhold Michigan taxes and you don’t have to worry about Ohio, even though that’s where you earned all of your income.

If an agreement exists, you’d reach out to your payroll department to request the exemption form. This can save you the trouble of having to file multiple state tax returns at least for each of the states that have the agreement.

How do you know if an agreement exists or not? This website lists all the states along with the necessary forms you have to supply to payroll to avoid the tax withholding from the state where you work. 

TIP: If there is an agreement and A) You don’t submit an exemption to avoid having income tax withheld from states where you are not a resident, and/or B) Your employer withheld the tax either inadvertently or due to state law, you can file a non-resident tax return in the applicable states and apply for a refund.

If there is NOT a reciprocal agreement, then the laws of each state have to be considered

I have had several New York residents who work in other states throughout the year inquire about this, as New York does not have a reciprocal agreement with any other states at this time. In that case, there are two steps here:

Step 1: If you’re a resident of New York or if the state where you’re considered a resident is not listed, you’ll need to check with your state to confirm your residency status and its withholding requirements based on that status. For instance, you may be considered a resident or a part-year resident and each of those could require a different set of tax forms to be completed or steps to be taken.

Step 2: For all other states in which you earned income, confirm your residency status (likely a non-resident in this case) and follow their tax filing guidelines for a non-resident.

Check the rules of each state here. For those unlucky New Yorkers, they may work out of the state every day of the year, but if they call NY home, they will still have to pay some of their income to their state.

At the end of the day, having an idea of what happens when you earn income in more than one state is already a positive. You may need to reach out to your payroll department to make sure they are aware of your residency status and are applying the rules per that state as well as the other guidelines mentioned here.

Then when it comes time to filing and ensuring you don’t overpay, it may be worth it to hire a tax pro – most DIY softwares are not equipped to file multiple non-resident returns in a way that can ensure you’re not over (or under) paying one state or the other.