Generally, you take the state tax credit for double taxed income on your resident state's tax return. That is, if you are a California resident, you would take the credit on your California return, see example 1.
However, there are a few exceptions for Arizona, Indiana, Oregon, and Virginia where we actually take the credit on that state's nonresident tax return, see example 2.
Why? Well there are states out there that use a different tax credit system called a "reverse tax credit". In a reverse tax credit situation, the other state (i.e., the exception states) allows for the double-taxation credit to be taken on their return first. A tax credit allowed by any state represents lost revenue to that state. So of course California wants you to take the credit on the other state's tax return first (when allowed) because they want to maximize their tax revenue.
What happens if I do it wrong? California can take the credit away from you and leave you high and dry. Let's look at a real world case (Appeal of Calvin); Calvin, a Pennsylvania resident, incorrectly used a CA resident tax return (instead of a CA nonresident return) to report his CA income. He subsequently took a state tax credit on his CA return for the PA income that CA double taxed. California reassessed his return, increased his liability, and left him with no state tax credit because he took it on the wrong return (CA instead of PA). The timing limitations to file an amended PA return has passed so Calvin could not adjust his PA return to take the credit that CA took away. He argued, unsuccessfully, that CA could not take it away. However, CA states that where a taxpayer fails to take their state tax credit in another state to prevent double taxation, the double tax cannot be recouped in CA (Appeal of Curtin).
Mitigating double taxation among states can seriously reduce your tax burden. Do it wrong, like Calvin from PA, and California will reward you with a large bill for the disallowed credit.
If you have questions on taking the credit on your return, feel free to send a note to firstname.lastname@example.org
California R&TC 18001-18011
California Schedule S
Appeal of Calvin, (Nov. 19, 2014) Cal. St. Bd. of Equal., Case No. 728341
Appeal of Curtin (July 14, 1943, 43-SBE-015
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