Why Out-Of-State Taxpayers Hire A Federal Tax Attorney

On Behalf of the Law Offices of Sammy Kim

Quick Summary

State income tax obligations do not always stop at the state’s border. Individuals and businesses operating across multiple states often face tax obligations in states where they do not live. The rules for when an out-of-state taxpayer owes income tax are state-specific, and the consequences of getting it wrong include back taxes, penalties, and interest assessed by agencies that have their own enforcement tools.

What Creates State Tax Nexus For Individuals

Most states tax income earned within their borders by anyone, resident or not. An out-of-state professional who performs services in a state, even temporarily, may owe that state income tax on the income earned there.

Remote work has complicated this significantly. An employee who works remotely from a different state than where the employer is based may face tax obligations in their home state, the employer’s state, or both, depending on how each state applies its sourcing rules. Some states use a convenience of the employer rule that taxes remote employees based on where the employer is located rather than where the work is actually performed.

The rules for determining when a nonresident owes state income tax vary significantly by state. Some use presence-based tests that count physical days in the state. Others use source-based tests that follow the income to where it was earned. A tax attorney familiar with multi-state issues can determine what obligations exist based on the specific facts of the taxpayer’s situation.

Business Nexus And Pass-Through Taxation

For business owners, state tax exposure follows the business’s nexus, its connection to the state through property, payroll, or sales. Pass-through entities like partnerships, S corporations, and LLCs pass their income to members or shareholders, who may then face tax obligations in the states where the entity has nexus.

Understanding where the business operates and how each state treats pass-through income is essential before filing. A business owner who receives a K-1 from a partnership operating in multiple states faces a filing obligation in each of those states proportional to the entity’s activity there.

States have become increasingly aggressive about asserting nexus based on economic activity rather than physical presence. An online business that sells into a state above a certain revenue threshold may have nexus even without a physical office or employees there. Economic nexus rules vary by state and have changed frequently since the Supreme Court’s 2018 decision in South Dakota v. Wayfair.

Residency Changes And Part-Year Returns

Moving from one state to another during a tax year creates a part-year residency situation. Each state typically taxes the income earned while the taxpayer was a resident, plus any income from in-state sources earned after leaving.

Residency rules vary significantly. Some states are aggressive about claiming continuing residency even after a taxpayer has moved, particularly high-tax states that have a financial interest in maintaining the connection. Establishing a clean change of domicile requires documentation and sometimes specific steps depending on the state.

The domicile analysis looks at factors including where the taxpayer registered to vote, where their vehicles are registered, where they maintain a bank account, where their family lives, and where they spend their time. A taxpayer who claims to have moved but maintains a strong economic and personal presence in the old state may find that state still treating them as a resident.

What To Do If You Receive A State Tax Notice

Out-of-state taxpayers who have not filed in a state where they had an obligation often receive a notice or assessment from that state’s revenue department. These notices should not be ignored. The assessment may be based on income information the state received from an employer, from federal return data, or from information returns filed by third parties.

The options for responding to a state tax notice depend on whether the assessment is accurate and what the underlying filing history is. If the taxpayer had a filing obligation but did not file, voluntary disclosure programs in many states offer reduced penalties for taxpayers who come forward before an audit is opened.

If the assessment is incorrect, because the state has wrongly concluded the taxpayer was a resident or that income was sourced there, the taxpayer has appeal rights similar to those available at the federal level. State tax appeals processes vary, but most have an administrative appeal stage before the matter goes to court.

When A Federal Tax Attorney Adds Value

A federal tax attorney who handles multi-state tax issues adds value in situations where the state of origin of income is disputed, where residency is being challenged by a state, or where a business has nexus in multiple states and needs a coordinated filing strategy.

State tax agencies have become more sophisticated about identifying out-of-state taxpayers with potential obligations. Cross-state information sharing, use of wage data, and analysis of federal return information all contribute to states finding taxpayers who have not filed. An attorney can evaluate the exposure before a notice arrives, which is consistently the better position to be in.

Federal And State Issues Often Arise Together

Out-of-state taxpayers facing state compliance issues often have federal issues connected to the same facts. A taxpayer who was audited by the IRS over income sourcing may face a follow-on inquiry from a state revenue agency using the same information. A self-employed taxpayer dealing with an IRS levy may have state tax debt that compounds the federal collection problem.

A federal tax attorney who understands both the federal and multi-state dimensions of a client’s situation can provide more useful strategy than one who handles only the federal piece. Multi-state filing analysis, state audit defense, and coordination between federal and state resolution processes are all part of comprehensive tax representation for clients with income from multiple sources.

The IRS appeal process and the collection alternative programs, installment agreements and Offer in Compromise, apply to federal liabilities. State agencies have analogous programs, but the terms, eligibility criteria, and procedures vary significantly. Some states are significantly more flexible than the IRS in accepting compromise; others are more restrictive. Knowing the applicable state’s program before engaging is part of building the right strategy.

Taxpayers who have not filed in multiple states where they had an obligation sometimes face a choice between voluntary disclosure and waiting to see if they are audited. Voluntary disclosure programs typically offer reduced penalties and sometimes a limited lookback period. Acting proactively before an audit notice arrives is almost always the better outcome for the taxpayer in terms of total cost and resolution timeline.

Working With A Tax Attorney On Multi-State Issues

The Law Offices of Sammy Kim works with individuals and businesses facing multi-state tax obligations and out-of-state income tax notices. Call now at (703) 202-1005 to identify your exposure before a state agency does it for you.