Reciprocity and order of state tax entry

[allen_pierce-com]

Hello.  I retired 2 years ago at which time I moved our of California and am now a resident of Arizona.  A high percentage of my current income comes from the exercise of non-qualified employer stock options that are still taxable by the state of California since I was employed there when they were earned.

Arizona and California have reciprocity, which in this case means that I pay taxes on those options in Arizona at their low rate (~ 4%), and then when California taxes those same options at their higher rate (12+%) they give me credit for the taxes I already paid to my resident state of Arizona.  At least I think that is how reciprocity works!

I just finished entering my 2022 Federal tax input.  In order for the reciprocity calculations to work properly within the TurboTax state tax modules, should I enter my Arizona (resident) state tax info first and then California (non-resident), enter California tax info first and then Arizona, or doesn't it matter?

[GeorgeM777]

No, enter your non-resident state first (in your case California).  You are correct in that the order of state returns does matter.  When you enter your CA information regarding your NQSOs, TurboTax will calculate the tax due.  Then, when you complete your Arizona return, TurboTax will inquire about tax you paid to other states--California.  You are correct in that Arizona will give you a credit for having paid CA tax on the NQSOs.  Given the differences in tax rates, it's likely your credit will substantially reduce or eliminate your AZ tax.

In the My Info section of TurboTax, make sure to indicate that you earned money in more than one state, i.e., CA.  If you are using TurboTax CD/download, you enter your personal information in the Personal Info section.  

@allen_pierce-com

[TomD8 · Accepted solution]

AZ and CA are "reverse credit" states.  Normally an "other state credit" is granted by the taxpayer's resident state, for taxes paid to a non-resident state.  In "reverse credit" states, the credit is granted by the non-resident state.

This means that you will claim a credit on your non-resident CA return for the tax you paid to AZ on the income taxed by both.

In reverse-credit situations in TurboTax, one should complete the resident state return before the non-resident state return, which is just the opposite of usual.

Another aspect of the CA-AZ tax agreement is that CA residents who work in AZ can request to have no AZ taxes withheld from their pay by filing AZ Form WEC with their AZ employer.

https://azdor.gov/forms/withholding-forms/withholding-exemption-certificate