Tuesday, May 6, 2008


Most states that have income taxes require non-residents to pay tax on income earned in their state. The most frequent example is a taxpayer who works in one state but lives in another. If you work in New York but live in New Jersey you first pay state income tax to New York and then take a credit for the tax paid on the New Jersey resident return.

From my experience it seems that a majority of the states determine the tax on non-residents by first determining the state income tax that would be assessed if the person had been a full-year resident of the state, and then pro-rating the tax based on the amount of actual taxable income earned in the state divided by the total income determined as a full-year resident.

If the total state tax liability determined as if the taxpayer were a full-year resident is $1,000.00, and the actual amount of income taxable by the non-resident state is 30% of the total taxable income (if taxed as a full-year resident), than the non-resident state income tax liability is $300.00.

The tax is not determined by simply taxing the income attributable to the non-resident tax by the appropriate state income tax rate.

While working on a GD extension for a client who lives in Rhode Island but has Kansas-source income taxed by Kansas I came across one of the inequities of this method of tax computation.

For 2007 the taxpayer’s federal Adjusted Gross Income (AGI) was $18,000+ more than that of 2006, due to increased capital gain income reported on Schedule D. However the portion of the federal AGI that was subject to Kansas state income tax was $2,100+ less than 2006. The calculation of Kansas state income tax begins with the federal AGI, as is the case with many states.

Because the federal AGI was substantially greater, so was the Kansas state income tax determined as if the client had been a full-year resident. And because of the nature of the 2007 AGI increase, the % of Kansas taxable income as a non-resident to total taxable income as a resident was much smaller.

The bottom line – for $2,100+ less in state taxable income the client paid $254.00 more in Kansas state income tax!

It is true that the taxpayer received a credit for the tax paid to Kansas on the Rhode Island state income tax return – but it was not a dollar-for-dollar credit and the client still ended up with $140+ additional net “out of pocket”.

Who said taxes were fair?


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