Military Spouses Residency Relief Act

Military Spouses May Be Eligible For State Income Tax Exemption

Employers should be prepared to process new claims of exemption from state and local income tax withholding, based on the Military Spouses Residency Relief Act (P.L. 111-097) which was signed into law November 11th, but is retroactive to 1/1/2009.

The law is intended to benefit spouses of military personnel who move into a state to be with the service member. Any income earned for services performed in such a state will be exempt from state (and local) income tax and withholding. Instead, the individual’s former state of residence would remain the taxing state.

For example, a spouse might move from California to Delaware to live near an Air Force base which is their spouse’s duty station. Assuming the couple wished to retain their California residency (domicile) and intended to return to the state, any wages that the spouse earns in Delaware would be exempt from Delaware income tax withholding. The individual would instead pay and report state income taxes to California. (Employers are generally not required to withhold income taxes owed to other states if they do not have an established office or physical presence in the other state.)

This raises some questions for payroll practitioners; e.g., in the example above, should the employee’s 2009 W-2 show Delaware income tax earnings and withholding? ADP is working with state tax authorities to clarify their expectations, and generally the states will apply the law prospectively due to the late date of enactment. That is, 2009 Forms W-2 should show earnings and withholding as if the law had not taken effect. In 2010, qualifying earnings should be designated to the state of residence (i.e., California in the example above). Although the law is retroactive to January 1, 2009, generally taxpayers will need to file a state income tax return in the worked-in state to claim a refund of any taxes withheld in 2009.

However, states may vary on this and other questions, so employers should ask the state income tax agency for revised withholding exemption certificates (W-4 equivalents) and guidance on what documentation is required to support claims of exemption. This is important, because employers could be liable for amounts not withheld based on an invalid or unsupported claims of exemption under the Military Spouses Residency Relief Act. As of early December, most states had not issued new instructions or withholding certificates.

Click here to download a PDF summary of the Military Spouses Residency Relief Act.