State Tax Residency and Filing Requirements

Summary:  State level filing requirements can be tricky for those who move around during their careers with the same employer. It’s important to maintain correct witholding certificates with the states in question and to file timely using the correct status. It’s easier to have a filing requirement you don’t know about than you think.

Our Example

Taking a break from tax return prep for this post based on a discussion in a group on Facebook.  Many of our clients work overseas and move around quite a bit, several with nexus in the DC/MD/VA (DMV) region while wanting to maintain residency in their “home of record” or “home leave” states, the place they started from. I’ve adapted this blog post from a contribution I made there. While this is specific to clients covered by the Foreign Service Act of 1980, in general, the framework applies to anyone working overseas. I’ve used New York as an example but the general outline, with specific modifications for each state, territory, or district, applies.

Assume you are a resident of New York when you join the Foreign Service (or other agency — these comments do not apply to those covered by the SCRA). You will remain a resident of New York until either you or circumstances force a change. At the time of entry, you filled out a federal witholding certificate and a New York one. You then continue filing a resident state return until circumstances change that.

For many U.S. government employees, but this applies to any large corporation for which you may be moved around, the circumstance that changes the situation is an assignment (TDY or PCS does not matter) to the DMV region (or wherever your headquarters is located out of state) during which you exceed one of the DC/MD/VA (DMV) tests for residency. Note that the DMV authorities tax all income regardless of residency status after one of the test thresholds is passed (resident, part-year resident, or nonresident return required).  The tests Virginia applies, for example, can be found here: Virginia has an income threshold requiring one to file even if still a resident of another state, in that case filing a non-resident return.

State level witholding certificates should be regularly adjusted for those who anticipate having to file a state-level return whether it is resident, part-year resident, or nonresident, to match where tax is going to be paid. A few years ago, some employers in the DMV, including government agencies, began automatically changing witholding for permanent moves into the DMV but those working even temporarily (TDY in government terms) need to be careful to avoid having underwitholding penalties.

Once you have become a resident of a DMV jurisdiction, you will remain there even if you depart on an overseas assignment unless you take steps to return your tax domicile to your original state or another one in which you can establish residency.

Using New York as an example, we have this hypothetical. Individual with New York residency joins the U.S. Foreign Service (State Department). Remains a New York resident and files a New York resident return to reconcile New York witholding with New York tax due. If in the DMV for training and does not cross a DMV threshold, files a DMV nonresident return for years in which this is required by a DMV test, whether the physical presence test or the income test. Continues filing NY resident and getting credit for tax paid on a DMV return. Goes overseas and continues filing NY resident until crossing the NY Group B criteria found at the link below. Files nonresident NY from that point on until back in the DMV or NY and the cycle continues.

This is all so much easier for those covered by the SCRA, generally uniformed military.

New York has its own witholding certificate which does not allow those with New York residency to be exempt from witholding even if the taxpayer will have no tax due or meets the test for filing a nonresident return due to the nonpresence test. The federal W-4 is not an allowable substitute though we’ve seen situations in which an employer erroneously accepts it as such and will modify state witholding anyway. To be exempt from New York witholding, a New York resident must be young, or old or in the military and assigned out of state. Note all the “ands” in the conditions to qualify for exemption:

Most state level tax authorities have a definition of “source income” that looks to where the business or service the worker is performing is taking place. It does not consider where the employing entity is located (the corporate headquarters or government agency headquarters), but rather where the worker is located and working. For example, if I work in Virginia, as a U.S. State Department employee, I have Virginia sourced income regardless of the State Department headquarters officially being in the District of Columbia. If I were assigned to United States Mission to the United Nations, I would have New York sourced income according to New York.

Have fun playing with the endless combinations and permutations of this framework throughout your careers!  Be careful though with the statute of limitations built into most state level jurisdictions’ tax laws. Generally, if no return is filed, no clock has started on the time limitation. These issues could pile up into quite a disaster over many years. Some states (and the District) can be quite aggressive once they detect a revenue opportunity.

These comments do not constitute tax advice and are offered for discussion only. Consult with a qualified tax professional to discuss your specific situation.

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