A tax reciprocal agreement is established when two states agree to avoid the burden of dual taxation on employees who live in one state while working in another state. The contract exempts the employee from taxes in his or her work state while requiring payment only to the home state.

For example, Illinois has reciprocal agreements with Kentucky, Michigan, Iowa, and Wisconsin. Therefore, employees who work in Illinois and live in any of those four states pay taxes only to their home state. Likewise, employees who work in any of those four states but live in Illinois pay taxes only to Illinois.

The following states have reciprocal agreements:

  • Maryland with Pennsylvania, Virginia, West Virginia, and Washington, D.C.
  • Montana with North Dakota
  • Minnesota with Michigan and North Dakota
  • Indiana with Michigan, Kentucky, Ohio, Pennsylvania, and Wisconsin
  • Washington, D.C with Maryland and Virginia

Other states may have reciprocal agreements as well, so check with your state’s taxation agency to determine whether your state has any such agreements. If not, and an employee lives and works in different states, and they each impose income tax, then he or she must pay taxes to both states.

Applicable Taxes and Earnings

Reciprocal agreements apply to the state and local taxes due in an employee’s state of residency. They do not affect federal employment taxes, which are owed no matter where an employee lives or works. Generally, reciprocal agreements cover all types of wages earned in the reciprocal home state.

Payroll Considerations

Employers are not legally required to withhold taxes for the employee’s home state, although many choose to do so as a courtesy to the employee.

It is up to the employee to invoke the reciprocal agreement by requesting that you withhold the necessary taxes. In this case, the employee must complete and provide a tax exemption form for the work state so that no taxes are withheld for that state. The employee also must submit a separate withholding form to effectuate withholding for the home state. The employers then must withhold taxes from the employee’s wages according to the rules of his or her home state plus file annual Form W-2s with the home state. To withhold taxes for the home state, you must establish a reciprocal account with that state’s taxation agency.

If you withheld taxes for the employee’s work state instead of the home state, or if you withheld taxes for both states, the employee should file a return in both states. Additionally, the respective W-2 must reflect taxes withheld in each state. The employee can recover taxes paid to the work state by requesting a credit on his or her return for the home state or by filing a claim for a refund in the work state where the taxes were withheld (the required method depends on the state). Ultimately, the goal is to get the employee to pay taxes in only one state.

If you need additional guidance on reciprocal agreements that may apply to your home state, contact us today.