Overview — why nonresident filing matters

If you live in one state but earn money in another, that other state often has the legal right to tax the income you sourced to it. States use different residency tests and source rules, and many require nonresidents to file a state return reporting only the income connected to that state. Late or incorrect nonresident filings can trigger penalties, interest, and audit attention that are disproportionately costly compared with the tax due (California and New York are common examples; see California FTB and NY Department of Taxation and Finance).

(Author note: In my practice I routinely see clients surprised by nonresident obligations after a move or when taking on remote clients. Addressing state filing early—before returns are due—usually saves money and stress.)

Sources: California Franchise Tax Board (FTB) — Filing Requirements for Nonresidents (https://www.ftb.ca.gov/), New York Department of Taxation and Finance guidance on residency and telecommuting (https://www.tax.ny.gov/pit/), general guidance from the IRS and Consumer Financial Protection Bureau (https://www.irs.gov/, https://www.consumerfinance.gov/).

How do states decide when a nonresident must file?

States generally look at two things:

  1. Residency or domicile: whether you are a resident or nonresident under that state’s rules. Many states define residency differently from the federal government; check the state’s own rules. See our guide on “State Residency Rules: Determining Your Tax Home” for a practical checklist.
  2. Source of income: whether income was earned inside the state. Common sourced income types are wages performed in the state, rental income from in-state property, business income from activities in the state, and income from the sale of in-state real estate.

For example, if you live in Arizona but perform services in New York, New York may require you to file a nonresident return reporting the portion of income attributable to work performed there (Form IT-203 for New York). New York also applies a ‘‘convenience of the employer’’ rule in many cases that can pull telecommuters into the New York tax base — an exception many taxpayers overlook (NY Tax Dept.).

Step-by-step checklist to determine your obligations

  1. Identify where each paycheck, contract, rental property or business activity was performed or sourced.
  2. Review the destination state’s nonresident filing thresholds and forms (state tax websites list filing requirements). Example: California FTB has clear rules for nonresidents with California-source wages or rental income.
  3. Determine whether a reciprocity agreement exists between the two states (some neighboring states exempt nonresident wage withholding, but you still may have to file). See state tax websites for reciprocity details.
  4. Allocate income on each state return using the state’s prescribed allocation method (days worked, percent of gross receipts, or statutory sourcing rules).
  5. Claim a credit on your resident state return for taxes paid to other states (most states allow a credit to prevent double taxation; rules vary).
  6. File and pay by the state deadline; make estimated payments if required to avoid underpayment penalties.

Useful internal resources: How to file multi-state tax returns (https://finhelp.io/glossary/how-to-file-multi-state-tax-returns/) and Remote Work and State Residency (https://finhelp.io/glossary/remote-work-and-state-residency-avoiding-multistate-tax-surprises/).

Common types of out-of-state income and how they’re treated

  • Wages: Generally sourced to the state where the services were physically performed. Telecommuting rules can complicate this — New York’s convenience rule may tax a nonresident who performs services from home if those services benefit a NY employer.
  • Business or self-employment income: Sourcing may be based on where the work is performed, where customers are located, or a market-based sourcing rule for some states. Multi-state businesses often apportion income using payroll, sales, and property factors.
  • Rental and real estate income: Sourced to the state where the property is located; nonresidents will normally file a return reporting rental income and allowable expenses.
  • Investment income (dividends, interest): Usually taxable to the resident state, except where income is from property or business in another state.

Credits, reciprocity, and avoiding double taxation

Most states that tax nonresidents allow a credit on the taxpayer’s resident-state return for taxes paid to the nonresident state. The formula and limitations vary.

  • If you’re a resident of State A and paid tax on the same income to State B, State A will usually allow a credit — but you must follow State A’s rules for the credit and file the required forms.
  • Reciprocity agreements between states (common among adjacent states) often let you avoid filing or having withholding in both states for wages. However, reciprocity rarely covers business, rental, or other non-wage income.

Always document taxes paid to the other state (copies of filed returns and proof of payment) when claiming credits.

Employer withholding and telecommuter issues

Employers are responsible for state withholding and can be audited for misapplied withholding taxes. If you telecommute from State X for an employer in State Y, your employer may need to withhold for State X even if payroll is located in State Y. Conversely, some employers incorrectly withhold only for the employer’s state; you may need to file a nonresident return to recoup withholding.

If withholding was handled incorrectly, you have two routes: 1) request employer correction and refund, or 2) file a nonresident return in the withholding state to claim refund or credit. See our article on “State Withholding Nuances for Telecommuters” for practical remedies.

Penalties, interest, and audits

Failure to file required nonresident returns or to pay appropriate estimated taxes can result in: late-filing penalties, late-payment penalties, and interest on unpaid tax. In my practice I’ve seen relatively small balances balloon due to penalties and interest after several years. State audits can also assess additional tax if you misallocated income — keep contemporaneous documentation (time logs, contracts, invoices).

Practical examples

  • Jane (freelancer): Lives in Arizona, works for New York clients and spends occasional days on-site in NY. She must file a New York nonresident return (NY IT-203) for income attributable to New York work and report all income on her Arizona resident return, claiming a credit for NY tax paid where allowed.

  • Tom (consultant): Moved to Texas but continues to have clients and perform services in California. California required a nonresident return reporting California-source business income; he needed to estimate and pay CA estimated taxes during the year. Filing late would have exposed him to penalties and California interest.

Professional tips to reduce surprises

  1. Track work location daily. Keep a contemporaneous log of days worked in each state and client locations; many state apportionment rules depend on days or receipts.
  2. Ask employers about withholding. Confirm which state(s) your employer will withhold for when you change work location or telecommute.
  3. Use estimated tax payments. If you expect to owe state tax as a nonresident, make quarterly estimated payments to avoid penalties.
  4. Claim proper credits. When filing your resident return, claim the credit for taxes paid to other states to reduce double taxation — but follow your home state’s form instructions.
  5. Consult a CPA early. Small operations or freelance income often create multistate obligations; an hour of planning can prevent bigger costs later. In my practice, early mapping of revenue sources avoids most audit flags.

Common mistakes to avoid

  • Assuming only your residence state matters.
  • Failing to allocate income correctly across states.
  • Overlooking reciprocity exceptions or special sourcing rules (e.g., convenience rules).
  • Not making estimated payments when required.

Next steps and resources

Professional disclaimer: This article is educational and does not replace personal tax advice. State rules differ and change; confirm current requirements on the relevant state tax agency website or with a licensed tax professional.

Author: CPA with 15+ years advising individuals on multistate tax issues. External authoritative sources cited: IRS (general guidance), California Franchise Tax Board, New York Department of Taxation and Finance, and Consumer Financial Protection Bureau.