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7 State Income Tax Myths

Common misconceptions about state income taxes

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State income taxes are complicated, especially when each state has their own way of doing things. And 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 taxes to the state I live in

False. State income taxes apply not only to residents, but also to nonresidents and part-year residents. Most states require that you pay taxes on income you made while living in the state, as well as income earned from sources within that state. That means if you simply made income in a state, but never lived there, you would still owe income taxes to that state as a nonresident.

Myth 2: State income tax rules are the same as federal tax rules

False. Most state tax laws are similar to federal tax law, but each state usually differs from the federal rules in some way. Some states choose to omit only certain parts of the Internal Revenue Code (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.

Also see: Internal Revenue Code (IRC) Conformity

Myth 3: State income taxes are unconstitutional

This is true in a sense. The federal constitution contains clauses that prevent discriminatory taxes and state taxes that impede interstate commerce, but it does not ban state income taxes or any other state tax. Occasionally, state taxes will be challenged as discriminatory or as impeding interstate commerce, but this is generally not a defense against state income taxes.

However, there can be sections in a state's constitution that limit certain types of taxes. For example, in Virginia a property tax was levied on businesses 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. Although the case has not been decided yet, this is a good example of a situation where taxes could be unconstitutional, based upon the state's constitution, not the federal constitution.

Myth 4: I have to pay income taxes to the state where my employer is located

False. The location of your employer's corporate headquarters has no bearing on your state income taxes, unless you have actually worked in that state. However, if your employer withheld taxes for their state by accident, you would need to file a nonresident tax return in their state to receive a refund of those withholdings.

Myth 5: I don't have to file a return in a reciprocal state

False. If you live in one state and work in another, reciprocal agreements exempt you from paying income taxes to the state you work in. However, if you have not filed an exemption form with your employer or taxes have been withheld for your work state by mistake, you'll still need to file a nonresident return to get those withholdings refunded.

Myth 6: I got audited, and everything was fine. Therefore, I did everything right on my return.

False. If you get audited by the state, their primary objective is to find mistakes that have led to underpayments. If you have left off a deduction, if you qualified for a credit but didn't use it, or any other situation where you may have missed tax saving opportunities, it's your responsibility to find those errors and file an amended return. An auditor will not be looking for those types of mistakes and will usually not volunteer that information. If you have miscalculated a deduction to your detriment, and an auditor finds that mistake, that is something they would likely tell you about, but they will not scout out tax savings for you. So, just because you got a good report from your auditor doesn't mean that you haven't overpaid your taxes. It simply means you haven't underpaid.

Myth 7: I don't owe taxes because I live or 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 that state. If you are a resident of the other 41 states that have an income tax, you'll have to pay tax to your home state on all of your income regardless of where you earned it, including income you made in a state without an income tax.

Similarly, if you are a resident of a tax-free state, and have worked in a taxing state, you 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. You would file a nonresident return to pay these taxes.

Source: TurboTax Myths and FAQ's

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