Income earned in a state I'm not a resident of

[smsboodoo]

I'm married and we are residents in MN, but my income is earned in IL and we also own a home there too. My wife's income is earned in MN. We typically file jointly and file both MN  and IL state taxes. Neither of us are IL residents. What I'm struggling with is it looks like both of our incomes are being used to determine IL taxes. My wife's income is solely earned in MN, so I would think it's just my income that should be used to determine IL taxes and since we are residents of MN, both would be used for MN.

The other part is what advantages would I have if we filed separate? Also, would it be better if I became a resident of IL if we file separate? There are potentially other tax savings such as Homestead on property taxes in IL that I could take advantage of if I were a resident. My wife would remain a resident of MN, which should allow us to remain homestead in MN.

I ultimately need to figure out our best tax situation, because we have been consistently paying high 4 figures come tax time.

[hbl3973]

smsboodoo,

There are a number of issues here to explicate.

1.  Unitary Taxation

The federal government and the state of Minnesota have graduated income tax rates that increase with increasing income.  (Illinois has a flat rate of 4.95%.)  States use the unitary taxation method to ensure taxpayers with large US/worldwide income pay a tax rate on the state income that is consistent with what they would have paid had all their income been earned in that state.  This method calculates that state tax that would have been owed had all the income been earned in that state and then prorates it by the fraction of income actually earned in that state.  (There is also proration of exemption credits and standard deductions.)

Of course application of unitary taxation to Illinois has minimal impact as IL does not currently have a graduated tax rate.  The main impact is the prorating of the exemption amount.

2. Credit for Other State Income Tax

As you may have noticed, the income earned in IL while you are MN residents is taxed by both IL and MN.  MN accounts for this by providing a tax credit on your MN return that is up to the amount paid to IL.  (There are adjustments for income that is nontaxable by one state but taxable by the other.)

3. Married Filing Separately

Minnesota does not allow a switch in filing status between federal and state returns.  Illinois does, though their IL-1040 instructions specify only a very few situations under which they say to do so.  The undated site https://www.vitastateguide.com/stateinstructions/www/illinois.html  suggests that MFS in IL saves some tax when only one spouse has IL income.  Not at all clear why that would be so, but you can always experiment.  In general, there is very rarely any benefit to MFS as both federal and state income tax significantly restrict credits and deductions in that event.

4. Residence

Your thought of declaring one spouse a resident of another state is not going to fly.  While residency is a somewhat fluid concept, it primarily depends upon where you actually live, receive and pay bills, register to vote, have a driver's license, etc.

I hope this has helped provide some clarity for you.