Live Here, Work There. Where Do I Pay State Income Taxes? 

by Elyssa Carlos | Mar 26, 2024 | Tax Planning

After weeks or months of job seeking, you land your dream job — but it’s in a different state. The location of the job is close enough so that you can commute every day rather than move. However, you are still faced with the dilemma of where and how to pay state income taxes. Here’s what you should know if you live in one state but work in another. 

Understanding State Residency 

State residency is a key factor in determining tax obligations. Most states define residency based on the amount of time spent within their borders. Generally, if you spend a certain number of days within a state, you may be considered a resident for tax purposes. However, residency rules can vary significantly from state to state. 

Domicile vs. Statutory Residency 

Some states differentiate between domicile and statutory residency. Domicile typically refers to the place you consider your permanent home, while statutory residency is based on the number of days you spend in a state during the tax year, regardless of domicile. Understanding these distinctions is crucial for tax planning. 

State-specific Rules 

Each state has its own rules regarding residency and taxation. For example, some states, like California and New York, have strict guidelines for determining residency, while others, like Florida and Texas, have no state income tax, making residency less of a concern. 

Do I Pay State Income Taxes Where I Live Or Work?

The easy rule is that you must pay nonresident income taxes for the state in which you work and resident income taxes for the state in which you live, while filing income tax returns for both states. However, this general rule has several exceptions. One exception occurs when one state does not impose income taxes. Another exception occurs when a reciprocal agreement exists between the two states.  

States with No State Income Tax

As of 2023, there are currently nine states in the U.S. that have no state income tax: 

• Alaska 
• Florida 
• Nevada 
• South Dakota 
• Tennessee 
• Texas 
• Washington 
• Wyoming 

New Hampshire taxes only dividend and interest income.

States With Reciprocal Tax Agreements

What if you live in Milwaukee but you commute every day by Amtrak to Chicago? It just so happens that Wisconsin and Illinois share what is known as a reciprocal tax agreement. Reciprocal agreements allow residents of one state to work in neighboring states without having to file nonresident state tax returns in the state where they work. As a result, your employer would deduct only Wisconsin state taxes from your paycheck, and none for Illinois. Likewise, if you live in Chicago but work in Wisconsin, your employer will only deduct Illinois resident state income taxes from your paycheck. In both instances, you would only be required to file one state income tax return. 

States Without Reciprocal Tax Agreements

If you are unlucky enough to work across state lines in a state with no reciprocal agreement with your resident state, (for instance, Illinois and Indiana), then you will need to file income tax returns for both states. However, you should also be able to claim a credit on your resident state income tax return for the state income tax that you paid for the nonresident state. The result is that you actually pay taxes for one state, even though you must deal with the hassle of filing returns in both states. 

For example, let’s say you are an Arizona resident and you received rental income from an investment property in Utah. These two states do not have tax reciprocity. So, you report this income to Utah and pay the appropriate tax. When you file your Arizona state tax return, you’ll need to pay taxes on the rental income, but you will receive a credit for the taxes paid to Utah. 

It’s important to note that reciprocity is not automatic. You must file a request with your employer to deduct income taxes based on your state of residence rather than where you work. Unless you make a formal request with your employer, you will continue to be taxed by both states and you will continue to be obliged to file two state income tax returns. 

Filing Multi-State Income Tax Returns

Many people are faced with the dilemma of working in one state and living in another, meaning they need to file a nonresident state tax return. People living and working in two different states often delegate the task of filing state income tax returns to a tax preparation expert, an accountant, or a tax attorney. Still, know that many online and home-based tax preparation software programs include state income tax forms with detailed instructions on how to file multi-state tax returns. If your tax situation is otherwise straightforward, you can save yourself a considerable amount of money by using a software program that includes both state and federal income tax forms and filing your own income tax returns. 

If You Need Tax Help, Contact Us Today for a Free Consultation 

Are Employee Stock Options Considered Income?

by Elyssa Carlos | Mar 21, 2024 | Tax Planning

Employee stock options (ESOs) have long been a cornerstone of compensation packages offered by companies. They are particularly common in the realm of technology and startups. ESOs represent a unique opportunity for employees to share in the success of the company they work for. They allow employees to potentially reap significant financial rewards as the company grows. However, amidst the allure of potential wealth, a critical question looms: Are employee stock options considered income? 

What Are Employee Stock Options? 

Employee stock options (ESOs) are a form of compensation commonly offered by companies to their employees. They grant employees the right to purchase a specified number of shares of company stock at a predetermined price within a designated period of time. This price is known as the exercise or strike price. These options typically vest over time. This basically mean that employees become eligible to exercise them in increments as they fulfill certain conditions. These can include remaining with the company for a certain number of years. When discussing ESOs, there are two main types that are often seen. These are incentive stock options (ISOs) and non-qualified stock options (NSOs). You may also hear about restricted stock units (RSUs). However, RSUs are technically not options and therefore, do not need to be exercised. 

Incentive Stock Options (ISOs) 

ISOs are typically offered to employees as part of a qualified stock option plan. They are subject to specific rules outlined by the IRS. If certain requirements are met, the gains from ISOs may qualify for favorable tax treatment. This is important because it could mean it is taxed at the lower capital gains rate rather than the ordinary income tax rate. One example is holding the stock for a specified period after exercise,

How Are Incentive Stock Options Taxed? 

When ISOs are granted to an employee, there are no tax implications. The employee does not recognize income at this stage. When an employee exercises their ISOs by purchasing the underlying stock at the exercise price, no taxes are owed. However, the spread between the exercise price and the fair market value of the stock on the date of exercise (known as the “bargain element”) may be subject to the Alternative Minimum Tax (AMT) in the year of exercise. Once you exercise an ISO, your employer must file Form 3921, Exercise of an Incentive Stock option plan under Section 422(b). Further, you may receive Form 3922, Transfer of Stock Acquired Through an Employee Stock Purchase Plan. This form helps determine your gain or loss, plus whether it is capital or ordinary income. 

How to Minimize Taxes on ISOs 

To qualify for favorable tax treatment, the employee must hold the shares acquired through the exercise of ISOs for a certain period of time. This timeline begins at least two years from the date of grant and one year from the date of exercise. If these holding period requirements are met, any gain or loss from the sale of the stock is treated as a capital gain or loss for regular income tax purposes. 

When the shares acquired through the exercise of ISOs are sold, the employee may be subject to either short-term or long-term capital gains tax. Which one depends on the holding period. If the shares are held for more than one year after exercise and two years from the date of grant, any gain is typically treated as a long-term capital gain. That said, it will be taxed at the applicable long-term capital gains tax rate. This is important because it is generally lower than the ordinary income tax rate. 

Non-Qualified Stock Options (NSOs) 

NSOs, also known as non-statutory stock options, do not qualify for the same tax treatment as ISOs. They are more flexible for companies to offer, as they are not subject to the same strict IRS regulations. However, NSOs are subject to ordinary income tax. The tax is on the difference between the exercise price and the fair market value of the stock at the time of exercise. 

How Are Non-Qualified Stock Options Taxed? 

Like ISOs, there are no tax implications when NSOs are granted to an employee. When an employee exercises their NSOs by purchasing the underlying stock at the exercise price, the spread between the fair market value of the stock on the exercise date and the exercise price is considered ordinary income for tax purposes. This amount is typically subject to federal income tax, as well as FICA taxes. It may be subject to state and local income taxes as well.  

How to Minimize Taxes on NSOs 

After exercising NSOs, employees may choose to hold onto the acquired shares or sell them. Any subsequent gain or loss upon the sale of the stock is treated as a capital gain or loss. If the shares are held for more than one year after exercise, any gain is typically treated as a long-term capital gain. Therefore, it is taxed at the long-term capital gains tax rate. As mentioned, this is generally lower than the ordinary income tax rate. If the shares are sold before one year from the exercise date, any gain is typically treated as a short-term capital gain. Short-term capital gains are taxed at the ordinary income tax rate. 

NSOs do not trigger the same AMT implications as ISOs upon exercise. However, the income recognized upon exercise may still impact an employee’s AMT calculation for the year. Employers are usually required to withhold taxes on the ordinary income recognized upon the exercise of NSOs. The amount withheld is based on the fair market value of the stock on the exercise date and the employee’s ordinary income tax rate. 

Tax Help for Employee Stockholders 

In conclusion, employee stock options are generally considered a form of compensation and subject to taxation. However, the timing and method of taxation can vary depending on the type of options granted and the specific circumstances. It’s essential for employees to seek guidance to ensure they fully understand the implications of their stock options. This will also allow them to make informed decisions regarding their exercise and taxation. Optima Tax Relief has a team of dedicated and experienced tax professionals with proven track records of success.   

If You Need Tax Help, Contact Us Today for a Free Consultation 

Who Must Pay Additional Medicare Tax?

by Elyssa Carlos | Mar 20, 2024 | Tax Planning

Medicare is a vital program in the United States, providing health insurance coverage to millions of seniors and certain individuals with disabilities. To fund Medicare, various taxes are levied, including the Medicare tax. However, there’s an additional 0.9% Medicare tax that targets higher-income earners. Understanding who must pay this additional tax is crucial for both employees and employers alike. 

Who is Subject to Additional Medicare Tax? 

The Additional Medicare Tax is an extra tax that certain individuals must pay on top of the regular Medicare tax. This tax came into effect in 2013 as part of the Affordable Care Act (ACA) to pay for free health services, such as vaccines, preventative care, health screenings, as well as some drug coverage costs. The tax applies to earned income, including wages, salaries, tips, and bonuses. It also applies to self-employment income railroad retirement (RRTA) compensation. However, RRTA compensation and wages are not combined to determine the Additional Medicare Tax. The key question then becomes: Who is subject to this additional tax? 

Individuals with Higher Incomes 

If you earn above a certain threshold from a single employer, you’re liable for the Additional Medicare Tax. As of 2024, the threshold remains the same as it was when the tax was introduced in 2013. For single filers, the threshold is $200,000, and for married couples filing jointly, it’s $250,000. For married couples filing separately, the threshold is $125,000. If your income exceeds these thresholds, you’re subject to the additional 0.9% tax. 

How is the Additional Medicare Tax Withheld? 

Employers play a crucial role in ensuring the correct withholding of the Additional Medicare Tax for their employees. When an employee’s wages reach $200,000 in a calendar year, the employer must withhold an additional 0.9% on all earnings above that threshold. However, this withholding is only applicable to Medicare wages. Medicare wages include total wages minus some benefit deductions, including insurance premiums, health savings account contributions, and dependent care FSA contributions. Employers will withhold regardless of your filing status and even if you won’t need to pay the additional Medicare tax during tax time.  

Self-employed individuals are responsible for paying the entire Additional Medicare Tax themselves. This means they need to calculate and remit the tax on their own when filing their income tax return. For self-employed individuals, the threshold is based on their net self-employment income rather than gross income. Finally, taxpayers should note that the Additional Medicare Tax is not deductible. 

Examples 

Let’s say Spouse A earned $210,000 and Spouse B earned $20,000 in a year. Their joint income would be $230,000. While this amount does not meet the joint filing threshold of $250,000, Spouse A would still have the additional Medicare tax withheld once they’ve earned $200,000. Any additional taxes withheld are applied to their taxes when they file their return.  

Now, let’s say Spouse A earned $180,000 and Spouse B earned $100,000. Their combined income of $280,000 is over the joint filing threshold. However, neither would get the chance to have the additional Medicare tax withheld. In this case, they would need to make estimated tax payments or request additional withholding from their employer on their Form W-4.  

Importance of Compliance 

It’s essential for both employees and employers to understand and comply with the regulations regarding the Additional Medicare Tax. Failure to withhold or pay the correct amount of tax can result in penalties and interest charges. Employers must ensure accurate payroll withholding, while self-employed individuals need to calculate and remit the tax correctly to avoid any issues with the IRS. 

Tax Help for High-Income Earners 

The Additional Medicare Tax is aimed at ensuring higher-income individuals contribute more to the Medicare program. It applies to both employees and self-employed individuals whose earnings exceed certain thresholds. Understanding who must pay this tax and how it’s calculated is crucial for complying with tax obligations and avoiding penalties. Employers and employees alike must ensure accurate withholding, while self-employed individuals should carefully calculate and remit the tax when filing their returns. Compliance with the Additional Medicare Tax regulations helps support the sustainability of the Medicare program for future generations. Optima Tax Relief has a team of dedicated and experienced tax professionals with proven track records of success who may be able to help with your state tax issues.  

If You Need Tax Help, Contact Us Today for a Free Consultation