According to a recent survey conducted by the Tax Foundation, a non-profit and nonpartisan tax policy research group, a huge majority (a whopping 88%) of survey respondents reported that they believed the tax code of the United States was overly complex. The bulk of the complaints were about tax issues and regulations that the public actually knew about. Interestingly, the survey also pointed out that, in actuality, there is much in the U.S. tax code that the American public isn’t even aware of, nor does it comply with correctly. Nonresident state income tax filings (the topic of this article) are one of them.
It’s true that navigating nonresident state tax regulations can truly be daunting. In that spirit, we offer this brief guide to help break through some of the fog and simplify the process to meet these tax obligations with less undue stress. Throughout, we also point out when a particular person’s circumstances can best be remedied by seeking external expertise via an accounting firm that can help handle the more intricate tax issues that may arise.
Understanding Nonresident State Tax Returns
Let’s first go global. For non-residents in the U.S., tax season can be particularly challenging. Not only must you grapple with federal tax obligations, but you may also have to contend with state returns if you’ve earned income in locations where you may not even be a resident. As states can have unique requirements for nonresident tax filings, understanding these nuances is crucial. And while you may need to file a state tax return in each state where you earned income, you need to know which ones even demand this (as multiple ones do not).
Let’s consider Vijay, an experienced software developer who moved from Jaipur, India, to the United States in 2023, only to find himself bewildered by multiple state tax obligations. Initially, he resided (temporarily) in California while working on a consulting project. A go-getter, Vijay also earned income from several remote projects in New York City and Plano, Texas, all within the same year. As it’s his first time navigating the U.S. tax system, he finds himself more than confused by the multiple state tax obligations. While Vijay is not yet a resident of any state but has earned income in multiple states, he knows he needs to file nonresident tax returns in California and New York. He also knows that Texas does not require the payment of state income taxes, but a return may still be necessary due to his self-business status. Then there’s the issue of tax payments in one state providing credits for taxes paid in another state. As he wants to avoid double taxation, he knows that understanding the intricacies well is important. So, what to do? For Vijay, he realizes the need for outside tax counsel to get through the process. (More on tax credits a bit later in this article.)
Determining State Residency
Paramount in the residency equation is how states define it. As it varies state by state, it affects tax responsibilities. On the whole, someone is considered a full-year resident if they’ve established domicile–a permanent place of legal residency or what’s also known as a “true home” –and spent at least six months in that state.
Also, if one earns income in a state where they don’t reside, they still may be obligated to file an additional nonresident tax return. For example, Mia, a specialized renal clinic nurse practitioner, worked several weeks as a contractor in Sonoma, California. Her primary residency is, however, in Utah. (Mind you, Mia’s residency in Utah was just made official within the past 2 months.) These laws mentioned indicate how state-specific regulations can be. For example, another specific regulation in Utah is that a resident there needs not to file a state return if they’ve worked in the state for 20 days or less. Again, the specifics can be confusing. (For more specifics on state residency rules, check this link.)
Filing Requirements and Deadlines
Another consideration is how filing deadlines can also vary by state (though they generally align with the federal deadline of April 15). Dates can vary, however, and range from Delaware’s April 30 deadline for the current tax year to Louisiana’s May 15 deadline for taxes due from 2023. Knowing each state’s specific filing deadlines (that are relevant to the specific taxpayer), as well as the requirements necessary to file, is important to avoid delays and penalties.
Take Ernesto, a freelance graphic designer from Manhattan. Most of his earned income is generated within the state of New York, yet he’s been residing close by in New Jersey for several years. He knows for sure that he has to file a nonresident return in New York due to his earnings there, as he faces a common challenge among Tri-state commuters who live in nearby states but work in New York City. So, he needs to file a nonresident return in New York due to his income there. Second, he has to file a resident tax return in the state of New Jersey (his home). And just as important, he needs to make sure that he gets money back from his home state, which offers a credit for taxes paid to other jurisdictions, such as, in this case, New York. Again, it is a somewhat complicated process.
Federal Return and Nonresident State Tax Return
While federal tax returns are standard, state tax returns often require additional information from that federal return. Filing both simultaneously typically makes sense since the information from the one sent to the IRS can inform your state filing. This ensures consistency and accuracy across your tax documents and is important as any discrepancies between a federal and a state tax filing return can trigger a delay in processing or, even worse, an audit.
Income Tax Withholding and Credits
Did you know that nonresidents can claim credits for taxes paid to other states? This is an important and not typically well-known matter when it comes to nonresident tax returns. Understanding what credits (and deductions such as those for dependent care or state taxes paid) are available can have a significant impact on the amount of tax dollars one owes. Additionally, total gross income can also affect eligibility for some of these credits.
Nonresidents must also know the impact of personal exemptions on their tax liabilities. The personal exemption amount can influence whether you even need to file a return if your income (depending on which state) exceeds a threshold. Qualified tax expertise can help to determine this.
Reciprocity Agreements
Here’s an added twist. Some states have agreements with others that allow a resident of one state to work in another without facing the burden of double taxation. So, if you earn income in a state with such an agreement, you may only need to write a tax check to the state of your residency. According to Thomson Reuters, 16 states plus Washington D.C. have reciprocal agreements. For instance, New Jersey has a reciprocal agreement with Pennsylvania, while Pennsylvania has additional agreements with Indiana, Maryland, Ohio, Virginia, and West Virginia. While many of the reciprocities occur due to geographical proximity, interestingly, the state of Arizona has such agreements with a wider range and includes California, Indiana, Oregon, and Virginia!
Common Errors and Penalties
Here’s a quick list of common mistakes that taxpayers make when filing nonresident state tax returns. Take note so you, too, can avoid them and possible filing delays and penalties.
- Not Reporting All Income Earned: Make sure you report each and every dollar earned in your state, as underreporting can trigger an audit.
- Mistaking Tax Liability Calculations or Withholding: When doing calculations, check them twice or use tax prep software to avoid mistakes in tax liability determinations. (Outside tax counsel may also be the right step to take.)
- Filing Incorrect Tax Forms or Schedules: Since each state has its own specific forms for nonresidents, make sure you are using the right ones. You don’t want delays or outright rejections.
- Failing to Meet Deadlines or Requesting an Extension: As time waits for no man (or taxpayer) filing late, monetary penalties with additional interest due will be brought about. If you need more time, get an extension.
- Keeping Inaccurate Records or Documents: As with any tax return (nonresident or otherwise) keep accurate and thorough records of your income, deductions, and credits to support your return.
Ensuring Successful Nonresident Tax Returns with Counsel
Typically, errors in a return lead to penalties and interest. The above information on nonresidents can help in getting things right. Seeking help from a qualified tax professional can be the best path for those who are in complicated situations with nonresident returns. Before enlisting any tax prep service, remember to verify their qualifications and that they are well-versed in multi-state tax regulations to help with specific circumstances. They are also the ones who are best at monitoring any changes to the tax laws.
Last point: qualified tax assistance comes in handy when problems do occur. A reputable firm can represent your interests and work through the process whenever audits or other types of tax authority disputes arise.