State Tax Reciprocity Agreements: Multi-State Withholding for Small Business Owners

A state tax reciprocity agreement is a deal between two states that allows an employee who lives in one state and works in a different state to pay income tax only to their resident state. As the employer, you set up withholding for the resident state. When no agreement exists, you withhold for the employee’s work state instead.

Say you just hired someone who lives in Iowa to work for your Illinois-based consulting firm. Knowing whether a reciprocity agreement exists between those two states will tell you which state to set up withholding for.

See how state tax reciprocity works, which states have agreements, and how to set up payroll tax withholding.  

Running multi-state payroll? SurePayroll® By Paychex is built for small businesses managing employees across state lines.

What is a state tax reciprocity agreement?

A state tax reciprocity agreement, sometimes called a reciprocal tax agreement, is a bilateral arrangement between two states. When an agreement exists, your employee pays state income tax to their resident state only. You do not withhold for the work state. Without a reciprocity agreement, you generally withhold state income tax for the state where your employee performs the work, subject to the specific withholding requirements of the states involved.

The legal backdrop: In 2015, the U.S. Supreme Court ruled that states must provide appropriate relief from unconstitutional double taxation of interstate income. When no reciprocity agreement exists, employees commonly rely on resident-state tax credits to offset taxes paid to another state.  

Without an agreement, your employee may owe state income tax to both states: the work state withholds income tax from their wages as a nonresident, and their resident state taxes the same income as a resident. Reciprocity agreements limit tax liability to one state.

Not every state participates, and neighboring states don't always have state reciprocity agreements.  

For example, New Jersey and Pennsylvania do. If your employee lives in New Jersey and works in Pennsylvania, you withhold for New Jersey only. New Jersey and New York do not have a reciprocity agreement, despite sharing a border. The state combination determines your state income tax withholding setup.

Which states have reciprocity agreements

Sixteen states and the District of Columbia currently participate in reciprocity agreements. The chart below lists states that participate, resident state(s) covered, and the state-issued exemption certificate your employee files with you to stop state income-tax withholding in the work state.

If your work state isn't listed (such as Alaska, Florida, Texas, South Dakota, or Wyoming which do not have state income tax), or your employee's resident state isn't represented, withhold state income tax for your work state.

For more details, see state-by-state tax resources for employers.

Reciprocity agreements can change. States negotiate and end them independently. Confirm the current agreement status with your state's department of revenue or the Internal Revenue Service (IRS) before finalizing your employee's withholding setup. The information above reflects current agreements as of 2026.

How reciprocity affects your withholding setup

Confirm the state tax reciprocity agreement covers your work and your employee’s resident home state. Have your employee complete the nonresident exemption certificate for their home state. That form is your documentation for why you're withholding state income tax for the resident state instead of the work state. File it in the employee's permanent record and make sure to keep it current.      

You’ll only enter resident home state income tax withholding in your payroll system. Do not set up withholding for both states. If your employee moves or their situation changes, they need to give you an updated certificate. A change in residence means a new form and potentially a new withholding setup.

What happens when states don't have an agreement

When there isn’t a reciprocity agreement that covers your employee's work and resident state, you withhold state income tax for the work state. Your employee owes income tax to both states: the work state taxes their income as a nonresident and their resident state taxes the same income as a resident.  

Some states offer residents a credit for state income taxes paid to another state, which reduces that burden. Your employee claims that on their tax return. It doesn't affect how you run payroll.

Your optional step is courtesy withholding, when permitted under applicable state rules: voluntarily withholding resident state income tax in addition to work state income tax withholding. It's not required, but when you offer it, it can help your employee avoid a large payment at tax season and may minimize their need to make estimated payments throughout the year. If you offer courtesy withholding, apply it consistently across everyone, document it as your practice, and let your employee know what you will and won't withhold.

State unemployment tax follows different rules

Reciprocity agreements cover state income tax withholding only. State unemployment insurance (SUI) tax follows separate rules and is not affected by a reciprocity agreement.

SUI generally follows the work state, not where your employee lives. If your employee lives in Iowa and works in Illinois (a state pair covered by a reciprocity agreement), you withhold state income tax for Iowa, but you pay SUI to Illinois because that's the work state.

This distinction matters when you set up a multi-state employee for the first time. Don't assume the reciprocity agreement covers both obligations. Confirm which state you pay SUI to before you run payroll, and let your employee know that if they ever file for unemployment benefits, the claim follows the work state, not their resident state.

Set up multi-state withholding and run it consistently every pay period

Setting up multi-state payroll comes down to execution. You specify the employee's work location and resident home state in your payroll system. Withhold state income tax for the resident state when you have the non-resident certificate on file. Otherwise, withhold state income tax for the work state.  

Depending on the states involved, you may need to register your business in your employee's home state, work state, or both. Requirements vary by state. Check with your state agency or business advisor about your small business.  

SurePayroll is built for small business owners with multi-state employees. Enter your employee's state information once — SurePayroll calculates and deposits state withholding on your pay schedule.

Set up multi-state payroll with SurePayroll.

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