Double Taxation? Credit for Taxes Paid to Other States

May 16, 2024 by Carolyn Richardson, EA, MBA
Double Taxation written on notepad

According to the U.S. Census Bureau, approximately 60% of Americans live in the state they were born in. So many taxpayers have probably never faced the problem of having to file a state income tax return in more than one state. However, with the increasing popularity of remote work, even a taxpayer who is living in the state they were born in may not be working in the state they are living in and, for many taxpayers, that can cause a tax headache as they try to navigate filing tax returns both for the state they work in, and the state they live in. For these taxpayers, learning about the credit available to reduce their overall tax obligations is important.

Most of the states that have income taxes offer a credit for taxes paid to another state on the same income, although how that credit is calculated is not identical from state to state. Most of the states use a proportion of the amount of taxes paid on the income in one state, usually your home state, to the amount due to the other state. The important thing to remember is that the income subject to tax must be taxed in both states to receive the credit. If you are living or working in a state that does not impose an income tax (Nevada, Texas, Florida, New Hampshire, Washington, Tennessee, or Alaska) but you have taxable income from another state, the income is not being taxed in both places, and no tax credit is going to be available.

Another important thing to remember is that not all your income, or all your taxes paid, is available to claim for the credit. For example, if you own property in multiple states and are paying property taxes in each state, you won’t receive a credit for those taxes. Generally, the credit is only available for taxes paid on income, not property. Likewise, if you are receiving a pension from one state while living in another state, that income is only taxable in the state that you live in, even if you earned the pension in another state. Also, many states cap how much credit can be claimed based on their own tax rates, so if you move from a state that has higher taxes to one with lower tax rates, the credit may not fully offset the amount of tax you paid on that income in both states. Keep in mind that the credit is limited to the actual amount of taxes paid to the other state, not the amount of withholding. If your withholding is higher than your taxes due, you will receive the appropriate portion of that back as a tax refund regardless of any credit.

This situation gets particularly confusing when you move from one state to another during the tax year. While most Americans may still be living where they were born, that still leaves about 40% of the population who have moved during their life. Given that most people move because of job opportunities somewhere else or because they are retiring and downsizing to another cheaper state, if you plan to leave your native state, you will probably be facing this situation at some point in your life. Is the credit available in this situation? It really depends on what happens because of or during your move.

Let’s look at Anne’s situation. Anne is a native of California and has worked there all of her life. But in 2024, Anne gets a great job offer from another company that is located in Oregon. Anne will resign from her current position and, on May 1, she will pack her bags and move to Salem, OR, where she will start her new job on June 1. At the end of the year, Anne can expect to receive a W-2 from both her California job – which has California tax withholding on it – and her Oregon job, which likewise has Oregon withholding on it. Anne has to file tax returns in both states as a part-year resident of both states, but because there is no overlap between the two jobs or places where she lived, she won’t be able to claim the credit for taxes paid to the other state. The wages are only taxed in the state in which they were earned.

What if Anne continued to work for the same employer but moved to another state? If Anne fails to mention her move to her payroll department in a timely manner, she may have withholding taken for one state while she is living in another. In this case, some of those earnings may be used to claim the credit for taxes paid in another state. However, it’s unlikely that the credit will completely eliminate the amount of taxes paid to both on the overlapping income.

woman thinking about California and Texas tax ratesWe saw many taxpayers taking advantage of remote work during the COVID-19 pandemic. In many cases, taxpayers moved from “high tax” states, such as California or New York, to a low- or no-income tax state, such as Nevada or Texas. However, that doesn’t always relieve them of their income tax liability to the state they are still working in, even if they are working from 1000 miles away. All of the states use a rule called “income sourcing” to determine if a tax return is due, and some of the states are more vigilant about finding taxpayers who move but continue to work in their state, such as California. If Anne moved to Oregon but continued to work remotely for her California employer, she might be required to report all of her income in BOTH states, as she is now a nonresident of California with California-source income and a resident of Oregon. Both states will tax the income in full, but she can claim a credit on her Oregon income tax return for California taxes. But since Oregon’s tax rates are lower than California’s, she likely won’t receive a full credit for the taxes paid in CA from the state of Oregon.

Things can get particularly ugly for taxpayers when they move out of a state that uses a “convenience of the employer” test for sourcing the income. New York is particularly harsh in this regard, as that state considers your income to be New York-sourced as long as you work in a position that is connected to your employer’s office in New York, regardless of where you lived during the year and regardless of whether you ever stepped foot in the state of New York during your employment. We saw many taxpayers move from New York to Texas during the pandemic, thinking they were getting out of their income tax obligations for their work in New York, only to discover they were receiving bills from the New York Department of Taxation for taxes due on their wages. While it is possible to avoid this situation, most people working remotely for their NY employer will not be able to overcome the conditions that must be met to claim their job is not based in NY.

The good news is that most tax software will compute the credit for taxes paid to another state when it’s available, but it’s important to understand and enter the information regarding your income correctly. If you aren’t certain, it’s helpful to refer to the help screens in your tax software or to refer to the form instructions for all of the states that you are filing returns for to understand what income qualifies for the credit and how the credit is computed. If your living situation is particularly complicated and involves more than two states, you might want to consider hiring professional tax help for that year’s return and leave the worrying to someone else.

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Carolyn Richardson, EA, MBA
Learning Content Managing Editor

 

Carolyn has been in the tax field since 1984, when she went to work at the IRS as a Revenue Agent. Carolyn taught many classes at the IRS on both tax law changes and new hire training. In 1990, she left the IRS for a position at CCH, where she was a developer on both the service bureau software and on the Prosystevm fx tax preparation software for nearly 17 years. After leaving CCH she worked at several Los Angeles-based CPA firms before starting at TaxAudit as an Audit Representative in 2009. Carolyn became the manager of the Education and Research Department in 2011, developing course materials for the company and overseeing the research requests. Currently, she is the Learning Content Managing Editor. 


 

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