Why working from home could increase your tax bill

Richard Branson: I'm a great believer in people working from home
Richard Branson: I'm a great believer in people working from home

Working from home can be a dream for many. But for some, it can also mean a bigger tax bill.

If you live in one state but work remotely for an employer based in another, you risk paying more tax than you would if you lived and worked in the same state. In a few cases, you may even end up double taxed.

The good news: You can avoid this fate if your home state has a reciprocal tax agreement with a neighboring state, which establishes that your income would only be taxed by one of the two.

Such agreements exist in Illinois, Indiana, Iowa, Kentucky, Maryland, Michigan, Minnesota, Montana, New Jersey, North Dakota, Ohio, Pennsylvania, Virginia, West Virginia, Wisconsin as well as the District of Columbia.

Or, absent a reciprocal agreement, those who work from home some of the time may be allowed to split their income tax burden: They pay tax on income earned from home to their resident state, and they pay tax to their employer's state for days they work at the office.

But that's not always the case.

How you can end up double taxed

You risk being double taxed if you live in one state but work for a company based in New York, New Jersey, Delaware, Pennsylvania or Nebraska.

These five states apply a so-called convenience vs. necessity test. If they determine that working from home is a matter of convenience for you rather than a necessity for your employer, "you will owe taxes to those states on the income you earn during your work-from-home days," said Cosimo Zavaglia, an associate at the law firm Morgan Lewis.

Related: 3 reasons your boss doesn't want you to work from home and why she's wrong

New York is toughest in this regard, according to Roxanne Bland, a contributing editor to State Tax Notes.

For instance, to contend that working from home is a necessity, you must prove you could not possibly do your work at your employer's office or that your employer requires you to work from home as a condition of employment. You also may need to prove the employer has a business purpose to have an office exactly where you live or that you regularly hold business meetings at your home office and never use it for personal reasons. The list goes on.

"Very few telecommuters would meet this standard. Thus, New York's convenience of the employer test will likely result in double taxation of a telecommuter's income," Bland wrote in Tax Notes.

Related: The business traveler tax threat

That's because your resident state may also choose to tax the income generated by your working from home.

Fortunately, many states give you a tax credit for any taxes you pay to another jurisdiction. So effectively you end up only paying income tax to one state when all is said and done, although you still have to file two state tax returns.

But not all states are so generous. Connecticut, for instance, only gives residents a credit for taxes paid to another state for income earned in that other state. It won't give you a credit for money you earned working from your living room in Fairfield.

So if you telecommute from Connecticut to an employer based in New York you'll end up being double taxed on the portion of your income earned from home.

California has different rules. It taxes its residents on all income, regardless of where it's earned. So if you live in California and telecommute to an employer based in New York, you could be double taxed on at least a portion of your income as well.

When you'll simply pay more

More common than double taxation is the risk of paying more tax than you otherwise would if you simply lived and worked in the same state.

If you telecommute from Florida — which has no state income tax — but work for an employer in a state with an income tax, you'll likely end up paying that on some or all of your income.

Or if you work for a company in a state with a higher income tax than your home state, you'll end up paying the higher of the two amounts, according to Zavaglia. That's because your home state will only give you a tax credit up to the tax you'd owe if you earned all your income in-state.

He added that "this increase in total taxes is even more of an overall concern now that state and local taxes in excess of $10,000 are no longer deductible at the federal level."

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