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Reciprocal Agreements and What They Mean for Your Business

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Grace Ferguson

Unlike federal withholding, which affects employers on a universal scale, states have their own game plans when it comes to withholding. If you have employees that work and live in different states, they might be subject to reciprocal agreements.

What Is a Reciprocal Agreement?

This arrangement exists when states agree that employees in one state can work in a neighboring state while paying income tax only to their home state.

For instance, Pennsylvania has reciprocal agreements with Virginia, West Virginia, Indiana, Maryland, New Jersey, and Ohio. Employees who live in Pennsylvania and work in any of those states report and pay income tax only to Pennsylvania. They can also ask their employer to withhold Pennsylvania income tax from their paychecks.

Must Employers Withhold for the Resident State?

No. You may simply withhold income tax for the state the employee works in. This would, however, inconvenience the employee, who must then file and pay taxes to her home state plus request a refund from the state she works in. Because of this, many employers offer to withhold taxes for the employee's home state, as a courtesy.

Which States Have Reciprocal Agreements?

As of 2018, those states are Arizona, Iowa, Indiana, Illinois, Kentucky, New Jersey, Ohio, Maryland, Minnesota, Michigan, Montana, North Dakota, Virginia, West Virginia, Pennsylvania, District of Columbia, and Wisconsin.

What's the Best Way to Approach Reciprocal Agreements?

The state has done some of the work by providing employees with a way to avoid double taxation. You can simplify the process even more by taking the following steps:

  • Verify with the state department of revenue as to whether reciprocal agreements exist in your state. If so, find out the criteria that go for both you and the employee.
  • Inform employees of their responsibilities if they prefer to have state income tax withheld for their home state. In most cases, they're supposed to fill out (and give you) a form exempting them from withholding in their state of employment. Generally, you must send a copy of this form to the revenue agency in the state that the employee works.
  • Withhold state income tax for the employee's state of residency. This involves giving the employee a state withholding tax form to complete (if applicable) and using the withholding guidelines for the home state.
  • Pay and report the withholding tax to the state the employee lives in.
  • Note that reciprocal agreements have no bearing on local income tax withholding.
  • Stay updated on reciprocal agreement changes, as state laws may vary from year to year.

As mentioned, you're not obligated to withhold state income tax for the employee's state of residence. Likewise, the employee can choose to not have you withhold any tax for her home state, in which case, you must withhold for the state she works in.

If you agree to withhold for the home state, the employee is likely to appreciate it, as this saves her from having to file and pay taxes in one state plus apply for a credit in another state.

Grace Ferguson is a freelance writer with 10 years of experience in payroll and benefits administration.