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When you work in one state and live in another, income taxes can become confusing. Although you must typically pay income tax to your state of residence even if you earn your income outside the state, you may also owe income tax to the state in which you are employed.
State of Residence
If your state of residence imposes an income tax, you must typically report all income you earned during the year and pay tax at the appropriate rate, regardless of where you earned the money. However, in states that don't impose income tax, you won't need to report your out-of-state income. As of November 2012, states with no income tax include Wyoming, Washington, Texas, South Dakota, Nevada, Florida and Alaska.
State of Employment
In most cases, if the state in which you earned your income collects income tax, you must file a return. If your state of employment collects income tax, you must file regardless of whether you pay tax in your home state. If both states collect income tax, you may pay taxes on the same income twice. However, many states offer tax credits to individuals who have already paid income tax to another state.
If your home state has a reciprocal agreement with the state in which you work, you may be able to file a single return in your home state. Under a reciprocal agreement, you can request an exemption from withholding for the wages you earn out-of-state, and your employer will no longer send taxes to the state in which you work. In some cases, the employer may even be able to pay withheld taxes to your state of residence to make tax preparation simpler.
Even if you don't owe any additional tax in the state where you work, it may still be wise to file a return. Some states allow non-resident workers to reclaim withheld tax by filing a non-resident tax return. If you request a withholding exemption from the state where you work and your employer is unable to send taxes to your state of residence, you should make quarterly estimated tax payments to reduce your liability at the end of the year.