Washington businesses and residents frequently find themselves filing income tax returns with other states. For example, someone who moves to Washington state during the year will typically owe the state they moved from a part-year resident income tax return.
But even long-time Washington residents can find themselves owing income taxes and income tax returns to other states. If your business operates in another state, you will typically owe the other state a nonresident income tax return.
Furthermore, if you have investment income earned in another state, you will typically owe the other state a nonresident income tax return because of that investment. For example, if you own rental property in California, you owe California a state income tax return.
Unfortunately, these nonresident and part-year resident state income tax returns can be a little tricky. You must apportion or allocate both your income and deductions between your state of residence and the other states in which you’ve earned income. Here are the general rules for performing this apportionment and allocation:
- Earned income from wages and salaries gets allocated to the state of residence. In other words, if you’re a resident of Washington, your wages and salaries can only be taxed by Washington. (Washington doesn’t tax wages or salaries, by the way.)
- Investment income typically gets allocated to the state where the property or investment is located. For example, if you have a rental property located in Arizona and you’re a Washington resident, you need to report the rental income to the state of Arizona and you’ll need to file a nonresident income tax return with the state of Arizona… even if you’re a Washington resident.
- Business income typically gets sourced to states using a three-factor apportionment formula that assigns a third of the business income using sales, a third using business payroll, and a third using property.
This apportionment process is a little bit tedious, but to give you a very general idea suppose that a business makes $300,000 in profits.
- One third, or $100,000, of the business profits are apportioned based on where the firm’s property is located. If all of the firm’s property is located in Washington, $100,000 of the profits is apportioned to Washington state.
- One third, or $100,000, of the business profits are apportioned based on the payroll incurred in each state. If the firm has four employees who earn $50,000 a year—one each in Alaska, Idaho, Oregon, and Californi—$100,000 of the profits is apportioned evenly between these four states. This four-way split means that $25,000 of the profits go to Alaska, $25,000 to Idaho, $25,000 to Oregon and $25,000 to California.
- One third, or $100,000, of the business profits are allocated based on where sales occur. If the firms sales are evenly split between Nevada and Arizona, $50,000 of the profits are apportioned to Nevada and $50,000 to Arizona.
Summing up, then, this imaginary business making $300,000 in profits has its income apportioned in the following manner (see table below). Note that the firm would owe state income tax returns to any of these states that levy an income tax:
|Washington (apportioned through property)||$100,000|
|Alaska (apportioned through payroll)||$25,000|
|Idaho (apportioned through payroll)||$25,000|
|Oregon (apportioned through payroll)||$25,000|
|California (apportioned through payroll)||$25,000|
|Nevada (apportioned through sales)||$50,000|
|Arizona (apportioned through sales)||$50,000|
|Total apportioned business profits||$300,000|
Obviously, state income taxes can dramatically complicate your tax planning and preparation. For this reason, I regularly provide state income tax planning and preparation services to business and individual taxpayers. In order to prepare your state income tax returns, I use the same information needed to prepare your federal income tax return. (State income tax laws piggy-back on various versions of the federal income tax law.) In addition to the standard “federal income tax” information, I also need information about when you lived and moved from another state to Washington and about what business income you earned in the other state.