7 State Income Tax Myths
Common Misconceptions About State Income Taxes
Understanding state income taxes can be complicated because each state has its own tax code and its own way of doing things. This complicated web of differing tax rules can lead to a lot of misconceptions. Don't fall for these seven common myths about state income taxes this year.
Myth 1: I Only Have to Pay Income Tax in the State Where I Live
State income taxes apply not only to residents but to nonresidents and part-year residents as well. Most states require that you pay taxes on income you earn while living there, as well as on income earned from sources within that state. This means that if you cross the state line to work, you may owe taxes there even though you don't live there.
But here's a bit of good news: The U.S. Supreme Court ruled in 2015 that two separate states can't both tax the same income—it has to be one or the other. So if you work in New York and you pay taxes there, Connecticut can't also tax you on that same income just because you live there.
Myth 2: State Income Tax Rules Are the Same as Federal Tax Rules
Most state tax laws are similar to federal tax law, but each state usually differs from the federal rules in some respect. Some states choose to omit only certain parts of the Internal Revenue Code—which is the federal tax law—while other states omit nearly all of it. Some states have even created a radically different income tax system that uses a flat rate for all taxpayers instead of the bracketed tax rates that the IRS uses.
Myth 3: State Income Taxes are Unconstitutional
This is true...at least in a sense. The Constitution does include clauses that prevent discriminatory taxes and state taxes that impede interstate commerce, but it does not ban state income taxes or any other state taxes. Occasionally, state tax laws will be challenged as unconstitutional, as happened in 2015 with the Supreme Court's two-state ruling, or as impeding interstate commerce, but this is generally not a defense against paying state income taxes.
However, there can be sections in a state's constitution that limit certain types of taxes. For example, a property tax was levied on businesses in Virginia to pay for an expansion of the subway. One business challenged this tax, citing a section in Virginia's constitution that requires that all property in a taxable area be treated equally and uniformly. The business contended that this tax was unconstitutional because residential property owners did not have to pay the tax even though they would benefit from the subway expansion.
Myth 4: I Have to Pay Income Taxes to the State Where My Employer Is Located
The location of your employer's corporate headquarters has no bearing on your state income taxes unless you actually performed work in that state. But if your employer accidentally withheld taxes for that state, you would have to file a nonresident tax return there to receive a refund.
Myth 5: I Don't Have to File a Return in a Reciprocal State
Some states have reciprocal agreements between them that exempt taxpayers from paying income taxes to the states where they work if they live in the other. But you must typically submit an exemption form to your employer to avoid withholding of taxes from your pay. If you don't, you'd sill have to file a nonresident return to get those withholdings refunded.
Myth 6: I Got Audited and Everything Was Fine So I Did Everything Right on My Return.
If you get audited by a state tax agency, its primary objective is to find mistakes that might have led to you owing more. If you failed to claim a deduction you were entitled to, if you qualified for a credit but didn't use it, or in any other situation where you might have missed tax-saving opportunities, it's your responsibility to find those errors yourself and file an amended return. An auditor will not be looking for these types of mistakes and will usually not volunteer the information if you did goof.
Just because you got a good report from your auditor doesn't mean that you haven't overpaid your taxes. It just means that you haven't underpaid.
Myth 7: I Don't Owe Taxes Because I Work in a State Without an Income Tax
You cannot avoid state income taxes simply by working in a tax-free state. You have to also be a resident of a tax-free state. So if you don't happen to live in one of the seven states where there's no income tax, you'll have to pay tax to your home state on your income regardless of where you earned it.
Similarly, if you're a resident of a tax-free state and you worked in a taxing state, you'd still have to pay taxes to the state where you worked. Unless you are working in a reciprocal state, you will have to pay taxes to the state where you earned your income and you would file a nonresident return there.