Where Do You Pay Tax if You Reside in One State and Work from Other States?

During COVID-19 period, many employers implement work-from-home policy which becomes more and more popular. Which state tax does a remote employee have to pay if he/she lives in one state and works from other states?

Unless the taxpayer lives in tax-free states, a taxpayer needs to report all income to the resident state tax return regardless where the income is earned. These tax-free states are:

• Alaska
• Florida
• Nevada
• New Hampshire
• South Dakota
• Texas
• Washington
• Wyoming

Let’s look at these few scenarios.  These scenarios are for taxpayers who temporarily move to different states; the taxpayers also have an intention to move back to their resident state. For the state tax impact when moving and settling with a new state, please visit the post: Where Do You Pay Tax if You Reside in One State and Work from Other States?

Employer is located in one State, Employee works remotely from another State

Majority states levy on the income generated in the states where the employee is physically located.  However, there are 7 states (Arkansas, Connecticut, Delaware, Massachusetts, Nebraska, New York, and Pennsylvania) tax remote employees based on where the employer’s office is located.

Example

If an employee lives and works in California for a New Mexico company, California is the employee’s resident state. The employee needs to report all income from the remote work to California. As the time of writing this post, no income should be reported to New Mexico because the employee hasn’t physically worked in New Mexico during the tax year. However, if the employee travels to the head quarter and works, he/she may need to file New Mexico tax return.

Employee resides in one state and remotely works from other state(s)

If the employee earns money in a state where he/she is not a resident, the employee may have to file multiple state tax returns.  The first tax return is filed with the resident state to report income from all states – no matter where the income is earned.  The employee also needs to file the non-resident tax returns to report income earned from the non-resident states.  To avoid double taxation from resident and non-resident states, most resident states provide credits for the tax paid to non-resident states.  However, the credit is only up to the tax paid to the resident state; therefore, if resident state has lower tax rate than that of the non-resident state, the employee will end up paying double-tax on some portions of his/her income.

In general, taxpayers need to file the tax return and pay tax to non-resident states where the taxpayer earns income during the tax year. However, requirements vary from states to states.  Some states like Arizona don’t require employers to withhold tax if the remote employee is in Arizona for less than 60 days; however, remote employees who work in New York for even one day are required to file a tax return.

Example

Same as the above example, the employee resides still resides in California; however, he/she temporarily moves to his/her friend house in Indiana during the pandemic. The employee intends to move back to California when the pandemic is over. In this case, since California is still the employee’s resident state. Therefore he/she needs to report all income which includes income from both California and Indiana to California. The remote employee also needs to report the income earned and pay tax to Indiana for the time he/she physically works from Indiana.   California may give the employee some credits back to offset the tax paid. 

Author’s recommendations

To avoid a big surprise in April, the taxpayer should update the tax withholding by letting the employer know the new locations where he/she remotely works from.  If there is no withholding for non-resident states, the taxpayer may owe tax money; this may cause a big payment and penalty for not withholding.

States have their ways to find out taxpayers who don’t pay taxes if the taxpayers don’t report his/her work location.  States could audit the taxpayer. To find out where the taxpayer generated earned income, states can ask for all bills like utility bills, rental payments, kid school records, etc.

Multi-state tax filling and to get the right offset credits is complex.  Recordkeeping is important especially if the taxpayer work remote in multiple states during the tax year.   Tracking the time that the taxpayer spent in the state and be specific about the location, cities, counties; some counties and cities may levy taxes as well.

What if the taxpayer decides to move permanently to different a different state and remotely work from the new location?  I will have another post for state tax for employees who permanently move to different states.