Working from home quickly became the “norm” back in March or April for many workers who had traditionally worked from their employer’s location. In some cases, working from home means working from a different state than the employer. This situation could result in the unintended consequence of an unwelcome “surprise” at tax-filing time. While this could be an unusual situation, it won’t seem so rare if it happens to you.
In general, a state imposes income tax on the worldwide income of its residents, regardless of where the income is earned. Each state has its own rules to define a resident, but it’s usually someone who is lives in that state. If a worker earns income in a state other than where she or he lives, the worker files a Nonresident Tax Return and is taxed only on her or his income earned in that state. The worker would then claim a tax credit on her or his home state’s Resident Tax Return for taxes paid to the nonresident state.
It can get even more complicated, depending on the states involved. For instance, in addition to the credit for taxes paid to another state, many states also have a Second Residency rule. In that case, taxpayers who are a resident in one state, owns a home in another state, and are physically present in that other state for 183 days or more, are considered a resident and subject to income tax in that state. This could result in some income being taxed in more than one state.
Confused? I am, and I’m writing this! An example might help:
Brad is a resident of Wisconsin, living just across the border with Minnesota. He normally commutes daily into St. Paul for work and pays state income tax to Minnesota on his W-2 wages that are earned at his employer’s location. He then claims a tax credit on his Wisconsin income tax return for income taxes paid to Minnesota. That prevents Brad from paying state tax in two different jurisdictions.
Brad also owns a second home on a lake near Bemidji, Minnesota, where he and his family vacation for several weeks each year. In March 2020, Brad’s employer required him to telecommute rather than drive to his St. Paul office because of COVID-19 stay-at-home orders. Brad and his family decide to head up to his lake home to live and work during the pandemic. Brad spends most of the rest of the year living and telecommuting from Bemidji.
In this example, Brad is physically present in his secondary home in Bemidji for at least 183 days during 2020. Therefore, Minnesota will consider Brad to be a resident and tax him on his worldwide income. Wisconsin will also tax Brad on his world-wide income because he owns a home and considered to be domiciled (aka a resident)) of Wisconsin. That’s the unwelcome “surprise” at tax filing time.
Doing your homework before filing your 2020 state tax return is more important than ever, thanks to the COVID-19 pandemic. Depending upon the states involved and their respective state tax laws, as well as your work situation, now is the time to do all that you can to avoid any unintended consequence of working at home.