DEPARTMENT OF STATE REVENUE
Information Bulletin #28
(Replaces Information Bulletin #28 Dated September 2007)
DISCLAIMER: Information bulletins are intended to provide nontechnical assistance to the general public. Every attempt is made to provide information that is consistent with the appropriate statutes, rules, and court decisions. Any information that is inconsistent with the law, regulations, or court decisions is not binding on either the Department or the taxpayer. Therefore, information provided in this bulletin should serve only as a foundation for further investigation and study of the current law and procedures related to its subject matter.
SUBJECT: Application of State and County Income Taxes to Residents with Out-of-State Income and Nonresidents with Indiana Source Income
EFFECTIVE: Upon publication
DIGEST OF CHANGES: Aside from minor, technical changes, this bulletin has been changed from the previous version to provide guidance as to withholding requirements for Indiana residents with out-of-state income.
Full-year Indiana residents must report all income that is reported for federal income tax purposes on their Indiana individual income tax return (Form IT-40 or Form IT-40EZ). This includes all income, even if it is derived from sources outside Indiana.
Full-year nonresidents who received income from Indiana sources must file an Indiana individual income tax return (Form IT-40PNR). They are subject to tax on that part of their total federal income that is derived from or connected with Indiana sources. If the nonresident's only Indiana source income was from an Indiana partnership or S corporation, the nonresident shall be included in the entity's composite return and will not be required to file Form IT-40PNR.
Part-year Indiana residents must file an Indiana individual income tax return (Form IT-40PNR). They are subject to tax on that part of their total federal income that was received while they were residents of Indiana. Also taxable is income from Indiana sources received while they were nonresidents of Indiana.
If a joint federal income tax return is filed, a joint Indiana return is also required. If separate federal income tax returns are filed, separate Indiana returns are also required.
I. INCOME RECEIVED FROM INDIANA SOURCES
Income received from Indiana sources is considered Indiana income to nonresidents, except certain types of Indiana source income that are subject to tax only by the taxpayer's state of legal residence. Interest, dividends, royalties, and gains from the sale of capital assets are subject to tax only by the taxpayer's state of legal residence unless such income results from the conduct of a trade or business in Indiana. If a trade or business is conducted in Indiana, the income should be reported as Indiana income.
Income from a qualified pension, annuity, or profit sharing plan is subject to tax by the taxpayer's state of legal residence. Lump sum distributions from qualified plans are subject to tax by the state that, at the time of distribution, is the taxpayer's state of legal residence.
Deferred compensation other than from a qualified retirement plan, accumulated vacation, bonus, severance, sick pay, or income from a stock option plan are directly attributable to services performed and are taxable by the state where the services were performed.
Taxpayers may be subject to individual income tax by both their state of residence and the state from which the income is derived. The State of Indiana has entered into agreements with several states to eliminate the requirement of paying tax to two states on the same income. Tax treatment of out-of-state income depends upon the type of income and the state from which the income is derived.
In the case of tax credits, Indiana only allows credits for individual income tax paid to other states or localities. Other taxes such as property taxes, corporate income taxes, and unincorporated business taxes are not allowed as a basis for claiming such credits. A worksheet indicating how the credit was computed and a copy of the tax return filed with the other state must be attached to the Indiana return. Withholding statements or other evidence of tax payments will not be accepted. A copy of Federal Form 1116 (Computation of Foreign Tax Credit) must be attached if the credit is claimed for tax paid to a foreign country.
In computing the credit allowed by Indiana, adjusted gross income that is subject to tax in both states should be used as a basis for calculating the allowable credit. Adjustments that increase or decrease the taxable amount in other states should not be considered in calculating the allowable credit. For example, State A allows a deduction for medical expenses, but Indiana does not; therefore, the credit would be based on the income before the medical expense deduction.
III. RECIPROCAL AGREEMENT STATES
Five states have a reciprocal agreement with the State of Indiana. They are Kentucky, Michigan, Ohio, Pennsylvania, and Wisconsin. All salaries, wages, tips, and commissions earned in these states by an Indiana resident must be reported as if they were earned in Indiana. A credit cannot be taken for any taxes withheld by or paid to any of these states in connection with income from salaries, wages, tips, and commissions. If taxes have been withheld or paid to any of these states, a claim for refund should be filed with that state by filing that particular state's income tax form for nonresidents.
Residents of Kentucky, Michigan, Ohio, Pennsylvania, and Wisconsin who have Indiana income will report and pay tax on that income to their state of residence.
If a resident of one of the above states has wages, salaries, tips, or commissions from Indiana sources where Indiana state or county tax has been withheld, Form IT-40 RNR must be filed. A credit for Indiana state and county tax withholding amounts will be allowed, and any Indiana county tax liability will be figured. If a resident of one of the above states has income from Indiana other than wages, salaries, tips, or commissions, Form IT-40 PNR must be filed.
IV. REVERSE CREDIT AGREEMENT STATES
The reverse credit agreement applies to Indiana residents who have income from the following jurisdictions and to residents of those jurisdictions who have income from Indiana. Included are Arizona; California; Oregon; Washington, D.C.
For example, a resident of Indiana with rental income from property owned in a reverse credit state will file a resident Indiana return and include the rental income on the Indiana return. The taxpayer will file a nonresident return for the state where the income was earned and claim a credit for the taxes paid to Indiana on the rental income.
A resident of a reverse credit state with income from Indiana will file a resident return with his state of residence and include the Indiana income. The taxpayer will then file an Indiana Form IT-40PNR and claim a credit for taxes paid to the state of residence for the Indiana source income.
V. STATES WITH NO AGREEMENT WITH INDIANA
When a person receives income from any state, possession, or foreign country other than those covered in Sections III and IV, the taxpayer might be required to pay income taxes to both entities. The taxpayer may take a credit for taxes paid to other states against the taxpayer's Indiana adjusted gross income tax liability.
The credit is equal to the lesser of:
• The amount of income tax actually paid to the other state, possession, or foreign country on income from that entity;
• An amount equal to the Indiana income tax rate multiplied by the adjusted gross income taxed by both Indiana and the entity; or
• The amount of Indiana adjusted gross income tax due to Indiana for the tax year.
List of states with no agreement:
| || || ||
|Alabama ||Kansas ||New Hampshire ||Vermont
|Arkansas ||Louisiana ||New Mexico ||Virginia
|Colorado ||Maine ||New York ||West Virginia
|Connecticut ||Maryland ||North Carolina ||
|Delaware ||Massachusetts ||North Dakota ||
|Georgia ||Minnesota ||Oklahoma ||
|Hawaii ||Mississippi ||Rhode Island ||
|Idaho ||Missouri ||South Carolina ||
|Illinois ||Montana ||Tennessee ||
|Iowa ||Nebraska ||Utah ||
VI. NON-INDIANA LOCALITY EARNINGS DEDUCTION
A non-Indiana locality earnings deduction is available to those who pay income tax to a locality outside Indiana. The term "locality" refers to a city, a county, or another political subdivision, but not other state taxes paid or withheld.
The deduction is limited to the lesser of:
• The amount of income taxed by the out-of-state locality; or
Claim the deduction on the annual income tax return, Form IT-40 or Form IT-40PNR.
VII. COUNTY INCOME TAX CREDIT
All Indiana residents who are subject to a county income tax and are also required to pay income taxes to a locality outside Indiana are allowed a credit against their Indiana county tax liability. However, this credit is not allowed against the county economic development income tax (CEDIT).
The credit for taxes paid to a locality outside Indiana must be supported by a separate calculation of the credit. If the taxpayer is required to file a return with the locality in another state, a copy of the return must be submitted with the claim for credit. Withholding statements or other evidence of tax payment will be acceptable if no return is required to be filed with the locality outside Indiana.
Persons claiming a county credit for taxes paid to out-of-state localities must add the deduction taken for non-Indiana locality earnings back to their state taxable income after arriving at their county taxable income.
The allowable credit is equal to the lesser of:
• The amount of income tax actually paid to a locality in another state;
• The amount of adjusted gross income taxed by the locality outside of the State of Indiana multiplied by the county rate* to which the taxpayer is subject; or
• The amount of county tax due on the Indiana return.
*See the Rate Conversion Chart in the annual IT-40 Full-Year Resident or IT-40PNR Part-Year Nonresident individual income tax booklets for the appropriate rate to use to figure the credit.
On a joint return, the credit should be calculated separately for the husband and wife. Any unused credit attributable to one spouse cannot be used to reduce the other spouse's county tax liability.
VIII. WITHHOLDING REQUIREMENTS FOR INDIANA RESIDENTS WITH OUT-OF-STATE INCOME
When an Indiana resident earns wages in another state that also levies a withholding tax on wages and the non-resident employer does not have a business connection with Indiana, the employer is not required to withhold Indiana state and local income tax. Note: It might be prudent for the employer to voluntarily withhold state and local income taxes on the behalf of the employee or for the employee to make estimated income tax payments in accordance with the provisions found in Income Tax Information Bulletin #3, available online at www.in.gov/dor/reference/files/ib03.pdf.
When an Indiana resident earns wages in another state that also levies a withholding tax on wages and the nonresident employer has a business connection with Indiana, the employer is required to withhold both Indiana state and local income taxes, pursuant to IC 6-3-4-8
(a). However, in this situation, Indiana state and local income taxes should be withheld only to the extent that the employee's Indiana liability exceeds the taxes withheld in the employee's state of employment. While IC 6-3-2-1
(a) could be read to require an employer who is required to withhold the full Indiana rate (3.4%) over and above whatever rate the employer might be withholding with regard to another state's income tax, the Department does not require this.
Example: An Indiana resident works exclusively in Illinois. The Illinois employer withholds Illinois state income taxes on behalf of the employee at 5.0% (the income tax rate in Illinois). Typically, no additional withholding is required for Indiana income tax (rate of 3.4%) because the Indiana resident will be able to claim a credit on her Indiana income tax return up to the amount paid in Illinois. Note: The previous sentence is qualified with typically because the credit available to the Indiana resident would apply only if the employee does actually end up paying tax in the other state. Also, if the Indiana resident lives in a county with a local option income tax (i.e., any county other than Lake County), it might be prudent for the employer to voluntarily withhold an amount on the behalf of the employee because the credit available for state income taxes paid to another state does not apply to local income taxes paid to another state.
When an Indiana resident earns wages in another state that does not levy a withholding tax on wages and the nonresident employer does not have a business connection with Indiana, the employer is not required to withhold Indiana state and local income tax. Note: It might be prudent for the employer to voluntarily withhold state and local income taxes on the behalf of the employee or for the employee to make estimated income tax payments in accordance with the provisions found in Income Tax Information Bulletin #3, available online at www.in.gov/dor/reference/files/ib03.pdf.
When an Indiana resident earns wages in another state that does not levy a withholding tax on wages and the nonresident employer has a business connection with Indiana, the employer is required to withhold Indiana state and local income taxes, pursuant to IC 6-3-4-8
More information related to Indiana state and local income tax, including withholding information, can be found in various Department documents available online at www.in.gov/dor/3330.htm.
Posted: 05/30/2012 by Legislative Services Agency
Composed: Aug 30,2014 12:30:40PM EDT
version of this document.