Do you know the state income tax implications of the investments you are making? State income tax filing requirements cannot be ignored, especially when revenue-hungry states have been paying close attention to who may not be filing where required. Most taxpayers are not fully aware of the state income tax consequences that come along when they begin investing, working, or operating their company in multiple states. This article summarizes some key items you need to know about state income tax filing requirements for individuals in their capacity as an investor.
What triggers a state income tax filing requirement?
Taxpayers are usually familiar with income tax requirements for their home state. Are there other states where they should consider filing?
If a taxpayer invests in a flow-through entity, is the beneficiary of a trust, or owns rental property located in another state, they may be subject to state income taxes in that state. If they are reporting income from these sources on their personal federal income tax return, then they may be subject to state income tax reporting for that same income.
Ownership of stock in a corporation normally does not generate a state filing requirement for the owner, since corporations are not pass-through entities. The most common investments we see causing a new state filing requirement are from pass-through entities, trusts, or rental real estate that generate income or losses sourced to an activity that operates in another state.
Typically, state income taxes fall into one of three categories:
- Traditional State Income Tax – Most states fall in this category, which is based on a progressive tax system. This means that the more income you have in a given year, the higher the percentage of taxes you will pay at the state level.
- Flat State Income Tax – Some states currently use what is known as a flat tax system. You pay the same percentage in taxes no matter how high your income is.
- No State Income Tax – There are nine states that do not have an income tax on earned income. However, Tennessee and New Hampshire (which are typically included in this list) do have a tax on certain interest and dividends. The Tennessee tax is being phased out and will be completely repealed as of January 1, 2021.