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How do tax withholdings work

how do tax withholdings work

Great question. If one is a resident of one state, let's say New Mexico, then New Mexico will tax that person on ALL income earned REGARDLESS where it was earned. If one works in a state where they are NOT a resident (they call it a non-resident), let's say Colorado, then Colorado will tax them on only income earned in Colorado.

So, yes, income earned in Colorado will end up on both Colorado and New Mexico income tax return. Sucks, huh? Not to worry, most states (New Mexico included) have a provision to take the sting out of it (form PIT-ADJ). They allow you a credit for taxes paid to the other state. In general, if you have earned income that is taxable in both your resident state and another state, your resident state will decrease their tax by whichever is lower:

1) the tax paid to the other state

2) the tax owed in your home state on that income.

For example, if he earned $10,000 while in Colorado as a non-resident and the CO tax rate is 6.5%, CO will want $650. If New Mexico's

tax rate is 5.5%, they will want $550 on that same income. Step 1, do a Non-Resident tax return for Colorado and make sure they get their $650 (most will have already been paid through withholding), Step 2, do a New Mexico Resident tax return and fill out the PIT-ADJ (line 21) to get a credit of $550. If Colorado's tax rate is only 3%, you will owe CO $300 and your NM credit will now be only $300. The credit is whichever is less, the Colorado tax or the New Mexico tax on the same amount on income. Get it?

Now, as far as withholdings, his employer should only be withholding NM taxes when he is in NM and CO taxes when he is in CO. If they withhold NM and CO taxes when he is in CO, then he will probably get a nice refund when he does his NM taxes.

Hope this helps :)

By the way, ignore comments about not owing anything to Colorado. Colorado taxes all income earned in that state. You can't escape it legally.

TaxMan · 9 years ago

Category: Taxes

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