State Tax Reciprocity Agreements in the United States

A state tax reciprocity tax agreement is a provision that allows individuals who reside in one state and work in another to pay income tax only to their state of residence. This arrangement, originally designed for those living near state borders who commuted to work in a different state, has become more prevalent with the rise of remote work.

When hiring employees residing in a different state than your business’s location, it’s essential to check if their state of residence has a tax reciprocity agreement with your state. If such an agreement exists, you must withhold state taxes following the regulations of the employee’s home state.

To comply, both the employer and employee need state-issued certificates confirming the exemption from withholding taxes in the work state. These certificates should be filed before the employee’s payroll starts. In cases where no reciprocity agreement is in place, you can withhold taxes as you would for in-state employees. The employee can then seek a tax credit when filing their tax returns.

Currently, there are 17 states with reciprocity agreements, but it’s crucial to understand that reciprocity agreements are one-way. For instance, Arizona has a reciprocity agreement with Indiana. If your business is in Arizona and you hire an Indiana resident, you can follow Indiana state tax laws and exempt the employee from Arizona tax withholding. However, Indiana doesn’t reciprocate with Arizona, so different rules apply when the employee’s residence and workplace locations are reversed.

Table of Content

• 0.1 Key Points to Remember
• 1 The History of Avoiding Double Taxation
• 2 Understanding Tax Reciprocity
  • 2.1 The Mechanism of Tax Reciprocity Agreements
• 3 How State Tax Reciprocal Agreements Work?
• 4 Understanding Your Role in State Tax Reciprocity
  • 4.1 What Happens if Taxes Are Withheld for the Work State?
  • 4.2 States with No Income Taxes
  • 4.3 Key Considerations for Companies
• 5 Conclusion
• 6 Frequently Asked Questions
  • 6.1 What is a state tax reciprocity agreement?
  • 6.2 How do state tax reciprocity agreements affect payroll withholding?
  • 6.3 What if my state doesn’t have a reciprocity agreement with the state where I work?
  • 6.4 How can I ensure correct tax withholding under a state reciprocity agreement?

Key Points to Remember

• Reciprocal tax agreements simplify income tax payment for residents working across state lines.
• Residents in these situations often don’t need to file separate tax returns if they provide the necessary documents to their employers.
• You can find all the required forms on state websites, and your HR department likely has them available.
• Taxes for your work state will be withheld from your pay if you fail to submit the form, but you won’t lose that money. Your home state usually offers a tax credit equal to the amount you paid to your work state, even without a reciprocity agreement.
• Another option is filing a non-resident return in your work state to claim a refund for erroneously withheld taxes.

The History of Avoiding Double Taxation

Reciprocity rules address the issue of employees having to file multiple state tax returns—typically a resident return in their home state and non-resident returns in any states where they work to recoup erroneously withheld taxes. In practice, federal law prevents two states from taxing the same income.

The U.S. Supreme Court’s 2015 decision in Comptroller of the Treasury of Maryland v. Wynne confirmed that two or more states cannot tax the same earnings. However, filing multiple returns might still be necessary to ensure you’re not being taxed twice.

For instance, if you live in Connecticut but work in New York, New York can’t tax your income if you pay taxes on it to Connecticut. Connecticut should provide a tax credit for the taxes paid to the other state, or you can file a New York state tax return for a refund of the taxes withheld there.

Note: You won’t be taxed on the same income twice, even if your residence and work states don’t have reciprocal agreements. You’ll just need to spend a bit more time preparing multiple state returns and wait for a refund of any unnecessarily withheld taxes from your pay checks.

Understanding Tax Reciprocity

Tax reciprocity refers to agreements between states that simplify the tax obligations of employees who cross state lines for work. In states with tax reciprocity, employees are spared the need to file multiple state tax returns. When there’s a reciprocal arrangement between an employee’s home state and their work state, they are exempt from state and local taxes in the state where they work.

For instance, consider an employee who resides in Pennsylvania but commutes to work in Virginia, two states with a reciprocal agreement. This employee only needs to pay state and local taxes for Pennsylvania, and Virginia taxes are not applicable. Employers withhold taxes based on the employee’s home state.

It’s essential to note that tax reciprocity exclusively pertains to state and local taxes and has no bearing on federal payroll taxes. Regardless of residency, the federal government continues to collect its share.

The Mechanism of Tax Reciprocity Agreements

In states with tax reciprocity agreements, employees only pay taxes in their state of residence, not in the state where they work. For example, an individual residing in Arizona but working in California would not be obligated to pay state taxes in California due to their reciprocity agreement.

Employees are only required to file a tax return in the state where they are taxable. They need not file non-resident tax returns in states where they work, even if they want to classify their income as exempt. The only situation where an employee must file a state income tax return in another state is when there is no reciprocity agreement in place. However, employees must provide their employers with the appropriate tax form to prevent taxes from being incorrectly withheld.

From an employer’s perspective, tax reciprocity agreements simplify tax withholding. The company only needs to withhold state and local taxes in the state where the employee resides.

For workers employed in states lacking reciprocity agreements, they are not subject to taxation in both states. Federal law within the United States prohibits multiple states from imposing taxes on the same income. However, individuals working in states without reciprocity agreements may need to file state income tax returns in both or multiple states.

How State Tax Reciprocal Agreements Work?

Reciprocal tax agreements between states simplify tax compliance for employees living in one state and working in another.

Here’s a breakdown of some key reciprocity agreements:

States	Reciprocity Agreements	Employees Form
Arizona	Indiana, California, Virginia, Oregon	Form WEC (Withholding Exemption Certificate)
Illinois	Kentucky, Wisconsin, Michigan, Iowa	Form IL-W-5-NR (Employee’s Statement of Non-residence in Illinois)
Indiana	Kentucky, Wisconsin, Michigan, Pennsylvania, Ohio	Form WH-47 (Certificate Residence)
Lowa	Illinois	Form 44-016 (Employee’s Statement of Non-residence in Iowa)
Kentucky	West Virginia, Wisconsin, Michigan, Indiana, Illinois, Virginia, Ohio	Form 42A809 (Certificate of Non=residence)
Maryland	West Virginia, Pennsylvania, Virginia, Washington, D.C.	File Exemption Form MW 507
Michigan	Kentucky, Wisconsin, Indiana, Illinois, Minnesota, Ohio	Employees should file Form MI-W4 (Employee’s Michigan Withholding Exemption Certificate)
Minnesota	North Dakota, Michigan	Form MWR (Reciprocity Exemption/Affidavit of Residency)
Montana	North Dakota	Form MW-4 (Montana Employee’s Withholding Allowance and Exemption Certificate)
New Jersey	Pennsylvania	Form NJ-165 (Employee’s Certificate of Non-residence In New Jersey)
North Dakota	Montana, Minnesota	Form NDW-R (Reciprocity exemption from withholding for qualifying Minnesota and Montana residents working in North Dakota)
Ohio	Indiana, Pennsylvania, Kentucky, West Virginia, Michigan	Form IT-4NR (Statement of Residency)
Pennsylvania	Indiana, New Jersey, Maryland, West Virginia, Ohio, Virginia	Form REV-419 (Employee’s Non-withholding Application Certificate)
Virginia	Pennsylvania, Washington, D.C., Kentucky, Maryland, West Virginia	Form VA-4 (Employee’s Virginia Income Tax Withholding Exemption Certificate)
Washington, D.C	Washington, D.C.	Washington, D.C., is eligible for income tax withholding exemption
West Virginia	Pennsylvania, Ohio, Kentucky, Maryland, Virginia	Form WV/IT-104 (West Virginia Employee Withholding Exemption Certificate)
Wisconsin	Indiana, Illinois, Kentucky, Michigan	Form W-220 (Non-resident Employee’s Withholding Reciprocity Declaration)

Understanding Your Role in State Tax Reciprocity

Your role in the context of state tax reciprocity primarily involves accommodating your employees’ tax withholding preferences. Here’s how it works:

1. Employee Request: Employees need to inform you of their tax withholding preferences. If they want taxes withheld for their home state and not their work state, they must request this.
2. Adjust Withholding: Upon receiving the employee’s request and their state tax exemption form, you should stop withholding taxes for the employee’s work state. Instead, begin withholding taxes for their home state as specified. This adjustment ensures that the correct state tax obligations are met.
3. Year-End Reporting: At the end of the year, you’ll use Form W-2 to provide employees with a summary of the state income taxes you withheld on their behalf. This document helps them in accurately reporting their state tax payments when they file their individual tax returns.

What Happens if Taxes Are Withheld for the Work State?

In some cases, when an employee resides in one state but works in another, you might initially start withholding taxes for the state where they work. If this occurs and taxes are withheld for the work state but not the residency state, here’s what happens:

1. Quarterly Tax Payments: The employee will need to submit quarterly tax payments to their home state to fulfill their tax obligations there.
2. Filing Multiple Tax Returns: When it’s time for the employee to file their individual tax return, they’ll need to submit a tax return for each state where you withheld taxes. This ensures that they account for all taxes paid, even to the work state.
3. Tax Refund or Credit: Typically, the employee should expect a tax refund or credit from their home state for the taxes paid to the work state. This ensures that they don’t pay taxes on the same income to both states.

Your role is crucial in ensuring that the appropriate state tax withholding is carried out in accordance with your employees’ preferences and that they have the necessary information for accurate tax reporting at the end of the year.

States with No Income Taxes

Nine states stand apart for not imposing state income taxes. Employees who work in these states but reside elsewhere need not submit any special documentation for working out of their home state. However, they are required to file and pay state taxes in their state of residence. The states without state income taxes are:

Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.

Key Considerations for Companies

Companies with employees working in states having reciprocity agreements should ensure that their employees submit the appropriate state tax form, as outlined in the previous section. Companies have the responsibility to withhold state taxes for each employee, so precision in tax withholding is essential. This applies to international employers with workers in the United States as well.

Even in states lacking reciprocity agreements, employers and their workers may have options, such as income tax credits. Thoroughly assessing the tax situation is crucial to ensure that both the company and the employee meet their tax obligations correctly.

Conclusion

In conclusion, state tax reciprocity agreements simplify the tax obligations of employees who work across state lines. Understanding these agreements is essential for both employers and employees. If you’re still facing challenges or have questions, don’t hesitate to reach out to our experts for guidance and assistance in navigating the complexities of state tax reciprocity. We’re here to help you ensure compliance and minimize tax-related complications.

Frequently Asked Questions