A reciprocal agreement tax refers to the tax rules established between states that have agreed to only tax their own residents, even when those residents work in the other state.
This simplifies payroll withholding for employers and eliminates the need for employees to file income tax returns in two states.
How do reciprocal agreement taxes work in payroll?
When a reciprocal agreement is in place, the employer withholds income tax only for the employee's home state, not the state where the work physically occurs.
To trigger this, the employee must submit an exemption certificate to their employer. Without it, the employer withholds for the work state by default.
Without exemption form | With exemption form filed |
Tax withheld for work state | Tax withheld for home state only |
Employee files return in both states | Employee files return in home state only |
Higher filing complexity | Simplified tax filing |
Which states have reciprocal tax agreements?
About 16 states plus Washington DC participate in reciprocal agreements, though not every pair of states has one. Common agreements include: Illinois and Iowa, Pennsylvania and New Jersey, Maryland and Washington DC, and Ohio and Indiana, among others.
You can confirm which agreements apply through each state's department of revenue or your payroll provider.
Do reciprocal agreements affect federal taxes?
No. Reciprocal agreements only cover state income tax. Federal income tax, Social Security, and Medicare are withheld the same way regardless of any state agreements.
Some local taxes, like the Philadelphia wage tax or Ohio municipal taxes, also fall outside of state reciprocal agreements and may still apply.
What types of income do reciprocal agreements cover?
Reciprocal agreements typically cover wages, salaries, and tips earned by employees. They do not apply to self-employment income, rental income, investment income, or business income.
Employees who earn multiple types of income may still need to file in both states for the non-wage portion.
What happens if an employee does not file an exemption form?
The employer is required to withhold for the state where work is performed, not the employee's home state. The employee would then need to file returns in both states and claim a credit for taxes paid to the work state.
This is more complex and typically results in extra paperwork at tax time, even if no additional tax is ultimately owed.
Key Takeaways
Description | |
Definition | State-level agreements allowing employees to pay income tax only in their home state |
How it works | Employer withholds for home state only when employee submits exemption form |
Scope | Covers wages and salaries; not federal tax, local tax, or non-wage income |
States involved | Approximately 16 states plus Washington DC participate |
Without exemption form | Employer defaults to withholding for the work state |
Frequently Asked Questions
Do all neighboring states have reciprocal agreements?
No. Agreements are negotiated individually and do not automatically apply to all border states. Always verify whether a specific pair of states has an active agreement.
Can an employee have taxes withheld for the wrong state by mistake?
Yes, if the exemption form is not filed or processed correctly. The employee can correct this at tax time by filing returns in both states and claiming credits where applicable.
What form does an employee use to claim a reciprocal agreement exemption?
Each state uses its own exemption form. For example, New Jersey uses Form NJ-165, and Pennsylvania uses Form REV-419. The employee submits it to their employer, not the state.
Do reciprocal agreements expire?
They can be terminated by either state with notice. Employers should stay current with their payroll provider or state revenue department to catch any changes.
