How to avoid double-taxation on multi-state tax returns
There are four main methods to avoid double-taxation on the state-side of your return. I will give some general details for each:
Allocate between the states
If the situation is that you moved during the year, you can allocate income to each state that you moved. This gives a clean cutoff of where income should be allocated. This gets tricky, however, if your W2 (or 1099) only shows one of the states or worse, shows the wrong state(s) altogether.
If that is the case, we would need to use a combination of the other strategies below, namely, credit for taxed paid to other states or state wage allocation.
Credit for taxes paid to other states
If the income being reported on your W2 was already taxed by another state, causing a double-taxation scenario, most states will allow you to take a “credit for taxes paid to other states.” This is an option in most professional tax software, so reach out if you need us to complete this. However, the general idea is that if you earned income in SC (source state) but drove back to your home in NC (residence state), then you would be paying taxes on your W2 to your income source state of SC but then applying a credit on your NC return for the taxes you paid to SC. This avoids double taxation on the states.
There are states that do not allow this, however, if you have moved at any point in the year – in such cases, the residence state providing the credit forces you to file a full-year return if you will be taking a credit. This causes us to be creative on how the return is to be filed presentationally while also maintaining legal compliance with state statutes.
State reciprocity agreements
Certain states have reciprocity agreements, such as DC and VA, where you only have to file in the resident state. Other examples of states that have agreements with neighboring states include Arizona, Illinois, Indiana, and Maryland.
Reverse Credit States
A great example of this is CA – if you are living in CA but working in OR, rather than paying taxes to the income source state (as my example above with SC and NC), you would only pay tax in your residence state
A note about city taxes
Cities such as Detroit, New York, and Philadelphia tax you based on your residence, regardless of where you earned your income, and credits for taxes paid to other states generally do not apply. These are unique situations & you can contact us if this applies to you to know more.