What is a Reciprocity Agreement?
We take a closer look at tax reciprocity agreements and its implications for employees and small business owners
Here's what you need to know:
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When an employee lives in one state but works in another, they may be subject to extra payroll taxes
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The exception is if both states have tax reciprocity agreements in place
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Reciprocity agreements mean that the employee only pays the taxes in the state where they reside
When it comes to payroll best practices, one of the terms you’ll hear is reciprocity agreement. But what exactly is a reciprocity agreement, and how does it impact the taxes you pay if you live and work in different states? Let’s take a closer look.
What is tax reciprocity?
When an employee lives in one state but works in another, they may be subject to extra payroll taxes. The exception is if both states have tax reciprocity agreements in place. In short, this is an agreement that both states have which lowers the tax burden for these employees. Reciprocity agreements mean that the employee only pays the taxes in the state where they reside.
How do reciprocity agreements effect federal payroll taxes?
Reciprocity agreements don’t effect federal payroll taxes — not for employees or employers.
Tax reciprocity only applies to state and local taxes. It applies to the wages that a person earns while employed, including tips, commissions, bonuses, and so on. These agreements are handled entirely between states, and not all states participate.
Which states have reciprocity agreements?
States in the eastern and midwestern parts of the U.S. generally have reciprocity agreements in place. If an employee is a resident of one of the states listed below, and works in another state listed, they can take advantage of reciprocity agreements.
Tax Reciprocity Agreement
| wdt_ID | Work State | Resident State | Non-Resident Certificate |
|---|---|---|---|
| 1 | District of Columbia | States outside of District of Columbia | D-4A |
| 2 | Illinois | Iowa, Kentucky, Michigan, Wisconsin | IL-W-5-NR |
| 3 | Indiana | Kentucky, Michigan, Ohio, Pennsylvania | WH-47 |
| 4 | Kentucky | Illinois, Indiana, Michigan, Ohio, Pennsylvania, Wisconsin | WH-47 |
| 5 | Maryland | Pennsylvania, Virginia, West Virginia | MW507 |
| 6 | Michigan | Illinois, Indiana, Kentucky, Minnesota, Ohio, Wisconsin | MI-W4 |
| 7 | Minnesota | Michigan, North Dakota | MWR |
| 8 | Montana | North Dakota | MT-R |
| 9 | New Jersey | Pennsylvania | NJ-165 |
| 10 | North Dakota | Minnesota, Montana | NDW-R |
How do employers set up proper withholding?
The employee must request that their state taxes be withheld.
As an employer, you must give your employee the proper tax exemption form. The employee must also make sure that they have calculated enough to be withheld. If tax is withheld from the wrong state (such as withheld from the work state instead of the home state), they can face penalties or fines.
And although these agreements exist for much of the eastern U.S., they are not in place for New Jersey, Connecticut, or New York, so if you work in one of these states (but live somewhere else), you’ll have to pay taxes withheld from both the state you live in, and the state you work in.
In addition, there are different forms to fill out depending on which state you live in, and which state you work in. It can be difficult and tedious to not only find the right form, but make sure that enough is being withheld to not be subjected to penalties. It can seem overwhelming, but with the right payroll software in place, accounting and payroll tax details like these are handled easily and efficiently.
Reciprocity agreements are just one of the many payroll hurdles that employers have to take care of in order to meet their tax obligations. That’s why it makes sense to choose a platform that takes these changes and agreements into account and does so in a way that helps make the process easier and more intuitive.
