On November 11th, the President signed into the law the Military Spouses Residency Relief Act. MSRRA gives taxpayers who follow a military spouse to a new location because of orders the option to designate their home state as their legal residence and pay state taxes there not in the state of current residence.
Legal residence generally is the state in which you live, vote and have a driver's license. For most of us, that is the state where we current reside. Not so with military taxpayers. When a taxpayer enters the military, they specify their state of legal residence and this determines what state income tax they pay. It is shown on their Leave and Earnings's statement (LES). So, Jane enlists in Kansas and sets Kansas as her legal residence. While she is in the service, Jane will not be subject to any state's tax but Kansas. If, Bob, her husband, follows her to a post in California from Kansas, he would pay state taxes based on the states' residency rules. The first year, he could be subject to both Kansas or California depending on where his income came from. After that, generally he would be subject to California taxes. Jane would be considered to be a resident of Kansas and Bob a resident of California.
With the passage of MSRRA, Bob can elect to become a legal resident of his military spouse's legal residence as shown on her LES. Bob would then maintain a Kansas driver's license, vote in Kansas elections and pay taxes on the income earned in Kansas and not in California. This goes into effect in 2009. If there was CA withholding in 2009, Bob is entitled to get that money back. The catch is that there will be no withholding for the legal residence state and this could result in a balance due.
There are still a lot of details to be sorted out. Each state will have to work out how to handle the refunds of withholding. There are also issues taxpayers with self-employment income. To keep updated on this, there is a Facebook page dealing with MSRRA.