Earning Income in Multiple States
Have you ever wondered the following questions: What taxes do I pay if I work in one state and live in another? Do you get double taxed if you work in a different state? Why do I have to pay taxes in two states?
These are all great questions, and ones we will cover in this post.
Living in one state and working in another or earning income in multiple states can complicate even the simplest of tax situations. While this may pertain to you if you are a W-2 employee living in one state and working in another, these questions and situations arise more commonly with physicians who are performing locum tenens work and might be working in multiple states.
Here are the things you should know about your taxes if you are earning income from multiple states or living in one state and working in another.
Your Federal Taxes Don’t Change
Let’s start with something simple. No matter where you work (as long as it is within the United States), you need to file an individual federal tax return using IRS form 1040. Whether you live and work in Ohio, live in Illinois and work in Indiana, or work as a traveling physician in multiple states, your federal tax situation does not change. Federal taxes are the same across all states.
This goes for W-2 employees, self-employed individuals, freelancers, or anyone earning an income in the United States. All US taxpayers fill out the same federal tax forms and file them with the IRS.
However, when it comes to state taxes, this is where things start to get complicated.
How State Taxes Work When Earning Income From Multiple States or Living in One State and Working in Another
Each state has its own set of tax rules and tax forms. With 50 U.S. states, you can see how things might get messy quickly. It would be impossible for any person or blog post to tell you everything you need to know about each individual state, so here are the general guidelines when it comes to earning income from multiple states or living in one state and working in another.
Pay Taxes Where You Live and Where You Work
Typically, you pay taxes and file a tax return in the state you call your primary residence. This is regardless of where you work. So, if you work in the state of your primary residence, then you only need to file one state tax return.
If you live in one state and work in another, then you might need to file a tax return in your state of residence and the state in which you work. The same goes for if you live in one state and earn income in multiple states. You will need to file a tax return in the state in which you live and a tax return in each state you earned income. Some states only require you to file a return if you have earned above a certain amount of income in that state. You will need to check each states’ rules to see what this number is for the state in which you worked.
Do You Get Double Taxed If You Work in a Different State?
This is a great question, and the answer is no.
Some states have reciprocity agreements with each other. This means if you live in one state and work in another, and the two states have a reciprocity agreement with each other, then you will only need to file a tax return and pay taxes for the state in which you lived. For example, if you live in Ohio and work in Michigan, you will only need to file a tax return and pay Ohio taxes since they have a reciprocity agreement with each other. This goes for W-2 employees and 1099 contractors.
This eases the tax filing burden of taxpayers who routinely work in one state and cross over the border to work in another state. Each states’ laws are different, so check with your state of residence to see if they have a reciprocity agreement with the state in which you work.
One thing to note is if your employer incorrectly withholds income tax for a state in which you work even though you don’t need to pay taxes there because of a reciprocity agreement, then you will want to file a state tax return with the state in which you worked, so you can receive a refund for the taxes that were incorrectly withheld from your paycheck.
What if There Is No Reciprocity Between Two States?
You might need to file two state tax returns if your resident state and the state in which you work do not have reciprocity agreements with each other. You would file a resident tax return for the state where you live and a non-resident tax return for the state in which you work.
Don’t worry. You will not pay double tax in this scenario thanks to a 2015 U.S. Supreme Court ruling. This ruling states that it is unconstitutional for multiple states to tax you on the same income. So if you need to file two state returns, one resident and one non-resident return, your resident state must provide a mechanism such as a tax credit for you to reduce your tax liability by the amount of taxes you had to pay to your non-resident state.
For example, let’s say you live in Kansas but work in Missouri. Since they don’t have reciprocity agreements with each other, you will likely need to pay taxes and file a return with both states. However, because of the Supreme Court ruling, Kansas must provide you a tax credit or other similar mechanism to reduce your Kansas state taxes by the amount of taxes you paid to Missouri, thus keeping you from paying double taxes on the same income.
These activities are much easier for W-2 employees who have employers withholding their taxes for them. If you are an independent contractor and receiving 1099s, you will have a lot more to handle on your own such as making quarterly estimated tax payments to all the states in which you work.
Independent Contractors Earning Income from Multiple States
Performing locum tenens work in multiple states will make your tax situation a little more complicated. When you work as an independent contractor, you receive 1099s instead of W-2s come tax time. This means you don’t have an employer who is withholding taxes and sending them to the IRS or state tax departments on your behalf. This responsibility is solely on you.
When you work as an independent contractor and earn income from multiple states, you will need to understand the tax implications of each state you work in. Since you are technically self-employed, you will be responsible for making quarterly estimated payments federally to the IRS and to each state in which you earned money. This includes income taxes and self-employment taxes. Depending on how much money you made in each state, you might not have to send estimates. It is state-specific, so work with a good tax accountant who can help you with this or understand each states’ rules on your own.
When it comes time to file your taxes, you will need to file a federal tax return, a resident tax return for the state you live in, and a non-resident tax return for any state in which you worked. Typically, you will record all of your income and deductions on your resident state tax return regardless of where it was earned. On your non-resident state tax returns, you will record only the income and deductions that apply to that particular state. Like we mentioned previously, your resident state must provide some mechanism such as a tax credit to reduce your tax liability on their return by the amount of taxes you paid to the non-resident states in which you earned money.
This could still lead to you paying more taxes overall since different states have different tax rates. Here is a simplified example.
You are a physician living in State A which has a state tax rate of 7%. You work in State B which has a state tax rate of 5%. Your income is $100,000. Since you work in State B, you will owe $5,000 in taxes to State B. Since you live in State A, you will owe $7,000 in taxes to State A.
However, because of the 2015 Supreme Court ruling, State A must provide a tax credit for the taxes you paid to State B. Thus, you would only have to pay $2,000 in taxes to State A. In total you are still paying $7,000 in taxes even though $2,000 is going to State A and $5,000 is going to State B.
If you decided to move to State B, you could reduce your tax bill by $2,000 per year since you live and work in the same state and would only be taxed at 5%.
An important concept to understand here is the concept of domicile.
When you have a domicile in a state, that generally means you have a home you reside in and you intend to return to or remain in that home. This is important because you can only have a domicile in one state, and the state in which you have domicile is the state which will levy taxes on your personal income, no matter where you worked to earn it. Each states’ laws are different about who is a resident, so you will need to check the laws for each state to see if you may be considered a resident.
If you are constantly on the go and don’t have a permanent state of residence, you will need to understand each state’s laws to determine how long you must live in that state in order to be considered a resident of that state.
Benefits of Being an Independent Contractor
A major benefit of being an independent contractor is you can deduct certain expenses from your income that traditional employees who receive a W-2 are not entitled to.
For example, if you perform locum tenens work and have to pay for scrubs or other work uniforms to perform your job duties, you can deduct the cost of the scrubs from your income which is a great way to reduce your tax bill. On the other hand, a physician who is earning a salary and traditionally employed by that same hospital will not be able to deduct the cost of the scrubs from their income. This is a huge benefit of being self-employed.
Another example is if you have to drive for your locum tenens work, you can deduct the mileage you drive on your tax return based on a predetermined rate set by the IRS. Your traditionally employed co-workers can’t take this deduction.
You will record your income and expenses on IRS form Schedule C if you are an independent contractor performing locum tenens work. It is even more important to track your income and expenses in detail when you earn income from multiple states so that you know how much money is allocated to each state. This will make filing your taxes much easier rather than waiting until tax time and trying to remember how much you earned in each state.
If you work remotely for a company that is headquartered in another state, you only owe taxes in the state in which you live since that is where you are performing the work. For example, if you live in Montana and work remotely for a company that is headquartered in New York, you only have to pay Montana state taxes.
This could be a great benefit if you live in a state with no income taxes and work remotely for a company with an HQ in a state that levies personal income tax. You wouldn’t have to pay state income taxes and could receive the benefits of working for a company that has great benefits and pay.
What If You Move During the Year?
Another possibility for earning income from multiple states in the same year is if you move to a new state during the year. If you are lucky enough to move to a state with no income taxes, you might not have to file a state tax return. However, only seven states (Alaska, South Dakota, Nevada, Florida, Texas, Washington, and Wyoming) currently don’t levy a personal income tax, so if you don’t move to one of these states, then you will need to file multiple state tax returns. You must file a tax return for each state in which you live.
In this scenario, you would file a part-year tax return, which is different from a non-resident tax return. Depending on the state, a part-year tax return will either be its own form, or it will be the same form as the normal, resident tax return, and you just check a box stating you were a resident in that state for a portion of the year.
For example, if you lived in Ohio from January to June, and moved to Colorado and lived there from July to December, you would record six months of income on your Ohio tax return and six months of income on your Colorado state tax return.
Some states do require you to record your full-year income on their tax return even if you moved out of the state during the year. Again, this depends on the state and will vary based on which state you are dealing with. If this is the case, the state requiring you to record your full-year income should provide you a tax credit to reduce your tax liability by the amount of tax you paid to the other state you lived in that year.
Know What to Do
Earning income from multiple states or living in one state and working in another can complicate your tax situation. It is important to understand the tax implications when you earn income from multiple states as you will be required to file multiple tax returns and pay different tax rates to different states. This not only increases the number of forms you need to fill out but could also increase the total amount of your tax liability depending on which state is considered your resident state.
While you won’t have to pay double tax when you experience one of these scenarios, you may end up paying more tax than if you lived and worked in one state with a lower income tax rate.
If you are uncertain how to handle one of the tax situations mentioned above, it may be a good idea to work with a tax accountant who has worked with clients in a similar situation.