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  1. #1
    Join Date
    Feb 2010
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    Default Which State Do I Have to Pay Income Taxes

    I live in Illinois and own some farm land in Iowa which I rent to farmers there for cash rent.

    The rental agreements, and cash flows, real estate taxes, etc are handled by a management firm in Missouri.

    Up until this past summer I have always declared the rental income on my federal and Illinois returns and paid the due taxes. Out of the blue this past summer, Iowa went back to 2004 and claimed I should have been paying them this whole time ( I have owned some of the land since 1996). They assessed the tax, added interest and penalties and demanded immediate payment or further penalties and interest would be added.

    Shocked, I paid what they required. But as I think about it, it is not clear to me that this was their right. I never go to Iowa and I do not enjoy their services etc.. I certainly cannot vote there. Furthermore, the farmers who rent the land pay income taxes to Iowa.

    Should I have been paying Iowa all along? Or, is Iowa over reaching their authority?

    Can someone clarify the basis upon which a state can tax you?

  2. #2
    Join Date
    Jun 2009
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    California
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    Default Re: Which State Do I Have to Pay Income Taxes

    Typically taxes are paid to the state in which you earn the money. You can file amended returns in Illinois showing taxes paid to Iowa. This can get complicated with multiple years involved and the taxes for all of those years actually paid in one year. It can also affect your federal returns if you itemized and claimed the taxes paid to Illinois as a deduction. You would be wise to see a tax professional to sort it out for you. You probably can recover at least part of the taxes that you paid to Illinois which were based on income actually earned in Iowa.

  3. #3
    Join Date
    Feb 2010
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    3

    Default Re: Which State Do I Have to Pay Income Taxes

    Thanks for your reply Scott. I greatly appreciate it.

    I have contacted my tax professional and paid all the fines and interest, and of course the taxes. I have also refiled my Illinois returns, but unfortunately was only able to go back 3 years.

    There is still something that does not smell right to me here, but maybe I just misunderstand the underlying concepts. This is a passive investment to me. I do nothing in Iowa.

    For instance, if I was to buy a certificate of deposit from a bank in Iowa, would I be obligated to pay Iowa income taxes on the interest earned?

    Thanks for your time and patience.

  4. #4
    Join Date
    Jun 2009
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    California
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    Default Re: Which State Do I Have to Pay Income Taxes

    Well, that's not quite right - you DO do something in Iowa. You are in business there. You own land and collect rent on it. It is really irrelevant that you pay a management firm to handle it for you -- I guess that's why you consider it a passive investment. Whether or not you can vote in a state is also irrelevant to paying taxes there. Whether you receive services of any kind from them is also irrelevant - and, from a philosophy point of view, many would argue that the value of your property as a rental exists because of services provided by Iowa (roads, infrastructure, etc.)

    State tax laws are not universal. Different states have different rules. For most states, your state of residence will give you credit in some form for income taxes paid to another state. So, in your case, Illinois would consider your income from Iowa as taxable in Illinois, but would give you credit for taxes paid to Iowa. The numbers do not always balance out exactly due to different tax rates applicable to the income in the different states.

    I have never heard of any state that discourages cash investment in the state by imposing a tax on CD interest earned in the state by non-resident investors, but I am not aware of any law that would prevent them from doing that. Common sense says it would not be wise, since investors would simply put their money in banks in other states.

  5. #5
    Join Date
    Feb 2010
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    3

    Default Re: Which State Do I Have to Pay Income Taxes

    Thanks again for responding. I am not an attorney which is why I am here.

    I guess it is so, and does not have to make sense to me; and it still does not.

    I pay real estate taxes on that land and never questioned their veracity. The farmers pay income taxes on the money they make from farming the land; that makes sense. Just as Iowa would not charge me taxes for funding one of their banks, I do not think they should be able to tax me for renting land that I already pay real estate taxes on. But it does not really matter what I think, especially since I cannot vote there.

    Thanks again for your help.

  6. #6
    Join Date
    Mar 2008
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    1,995

    Default Re: Which State Do I Have to Pay Income Taxes

    Quote Quoting tquinn
    View Post
    Thanks again for responding. I am not an attorney which is why I am here.

    I guess it is so, and does not have to make sense to me; and it still does not.

    I pay real estate taxes on that land and never questioned their veracity. The farmers pay income taxes on the money they make from farming the land; that makes sense. Just as Iowa would not charge me taxes for funding one of their banks, I do not think they should be able to tax me for renting land that I already pay real estate taxes on. But it does not really matter what I think, especially since I cannot vote there.

    Thanks again for your help.
    I own rentals in my own state, NY, and I also own rentals out of state, in MA.

    Here in NY State, if you rent out apartments, the state looks at it the same way as if I rented out land, i.e. it is a business just like any other, like selling lemondade. In any other business, I buy equipment, inventory, then I have customers, I make sales, with the resulting profits.

    In rentals, instead of inventory and equipment, you have a building or a piece of land. Instead of sales, you have rent. Your customers are your renters. Not only that, businesses have to pay taxes on their income even though they already paid RE taxes on their builidngs.

    What the state is saying is as far as they are concerned, if you have land, you collect rent on it, you are in the business of making money on the land. As to RE taxes, yea, it's just an expense that you can deduct against the rental income, like on the Schedule E for the Federal taxes.

    And they don't care if the owner lives in state or out of state.

    As far as your example of the CD interest on the Iowa bank, some states have gotten after people who moved out of state, and had 401K plans with money in the originals states, and wanted them to pay taxes on it when they withdeaw. With states being broke, don't start giving states like Iowa any new ideas, as they might start taxing you on the interest on the CD, as I see no illegality of it.

    Sometimes govenrments may not do things because of the difficulty of identifying the recipients and taxing of out of state residents on their CD interest, though legal, but may not yield much when it is all said and done. As an example, my municipality decided to surcharge RE taxes on "non owner occupied" properties, but dropped the tax after passage, because the way records are kept, there was no way they can figure out which properties are owner occupied, and which ones are not.

    If they decided to tax interest on CD's, they'll have to obtain the home addresses and headquarter addresses of companiies for every depositor, and then figure out if that is their legal address or just a mailing address, and try to collect a tax on a 2% return. The problem with the non owner occupied surcharge tax was in many cases the mailing address on file is just a mailing address, not the legal one.

    Some years back, I sold some property, I had to pay my Federal as well as NY State capital gains taxes, and it turned the State taxes are much higher than the Federal taxes, I recall twice as high. I had a talk with my CPA, and he said many people commented to him that they thought it was strange that taxes in NY State are even higher than Federal taxes.

    I think it's quite refreshing to hear people out west thinking that rentals are not even a business that states can legally tax. Here out in the east, I turn around, and there's another tax.

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