Discussion:State Tax on Unearned Income for Military

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Discussion Forum Index --> Basic Tax Questions --> State Tax on Unearned Income for Military

Discussion Forum Index --> Tax Questions --> State Tax on Unearned Income for Military

Miltaxman (talk|edits) said:

22 April 2010
I searched these forums, scoured the internet, read through state tax websites, and I still have not come to a conclusion on this question. Any advice would be appreciated.

Do military members and/or their spouses have to pay state (where they are stationed) income tax on interest/dividends/cap gains and other forms of unearned income (even if they have a different legal state of residence)?

I know that two main laws come in to play:

 (1) Servicemembers Civil Relief Act (SCRA) - mandates that military pay cannot be taxed by state solely because of his residing there because of military orders
 (2) Military Spouse Residency Relief Act (MSRRA) - spouse cannot be taxed on earned income for state if she is there solely because of a military move

It is clear that military members only pay state tax in their state of residence (not necessarily where they are stationed) for their military income and that spouses only pay state tax in their state of residence for earned income. But, what about unearned income?

For example, imagine that you have an active duty service member and his wife who both have their legal state of residence as South Dakota (no state income tax). If they are stationed in Ohio, would they pay Ohio State taxes on their interest, dividends, and capital gains from their investment accounts?

Any help would be greatly appreciated. Thanks!

KatieJ (talk|edits) said:

22 April 2010
Income from intangibles generally has its source at the residence of the owner. The only exception is where the intangible has acquired a business situs in another state. For example, stock that is held in a state as security for a loan to a business in that state, or that is an asset of a trade or business carried on in that state, would have a business situs there. Investment property of individuals, however, does not have a business situs and is sourced to the individual's residence.

You can find these principles in the statutes of most states defining the taxable income of nonresidents. NY Tax Law Sec. 631(b)(2) is just one example.

SCRA (before 2009) provides that a state may not consider a military member to have changed domicile or residence for tax purposes by reason of being stationed in the state on permanent military orders. In addition, the state where a nonresident member is stationed may not tax the member's military compensation on a source basis.

MSRRA extends the residency protection of SCRA to the civilian spouse of a military member, as long as he or she has the same domicile as the member. It also provides that the personal service income of the civilian spouse cannot be taxed on a source basis. Note that MSRRA, for some odd reason, does NOT protect from state taxation any non-military personal service income of the military member (e.g., earnings from a part-time job) earned in the state.

So, in your example, if both spouses are domiciled in SD (or anyplace else), Ohio cannot tax the investment income of the civilian spouse because he or she is a nonresident, and such income is taxable only by the state of residence. In fact, the only income of such a couple that Ohio COULD tax would be any earnings of the military spouse from part-time or occasional civilian employment in Ohio.

Of course, the state could tax any other source income of this couple, such as income from real or tangible personal property located in the state (e.g., rental property) or flowthrough income from an LLC, partnership, S corp, etc.

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