State tax reciprocity is a formal agreement between two or more states that allows residents working outside their home state to pay income taxes solely to their state of residence, avoiding double taxation. This arrangement primarily benefits commuters who live near state borders but work across state lines, ensuring they do not have to file income tax returns or pay taxes in both states. Instead, income earned is taxed only by the home state where they reside.

How State Tax Reciprocity Agreements Work

When states establish reciprocity agreements, employees working in a neighboring state complete a tax withholding exemption form provided by their work state employer. This form exempts income tax withholding by the work state’s tax authorities. Instead, the employer withholds taxes for the employee’s home state. As a result, the employee needs to file only one state income tax return—typically in their state of residence—streamlining the tax filing process.

Without a reciprocity agreement, individuals usually must file tax returns and pay income taxes in both their work state and their resident state. However, the resident state typically offers a credit for taxes paid to the work state to reduce or eliminate the burden of double taxation.

Regions and States with Reciprocity Agreements

Reciprocity agreements are most common in regions with significant interstate commuting, including the Mid-Atlantic and Midwest. Examples include agreements between the District of Columbia and Maryland, Virginia, and West Virginia; Illinois with Iowa and Wisconsin; Pennsylvania with New Jersey and Ohio (certain agreements); and Minnesota with North Dakota and South Dakota.

However, not all neighboring states have these agreements, so it’s important to check with your state’s revenue department for the latest information.

Who Benefits from These Agreements?

  • Commuters: Especially those living near state borders working across lines benefit by avoiding multiple state income tax filings and payments.
  • Employers: Must correctly apply withholding based on the employee’s residence and collect proper exemption forms.
  • Freelancers and Contractors: May face more complex filing requirements if working across states without reciprocity.

Real-Life Scenarios

For example, an individual living in Virginia but working in Washington, D.C., benefits from the D.C.–Virginia reciprocity agreement by paying taxes only to Virginia. Conversely, an Illinois resident working in Wisconsin, where no such reciprocity exists, must file returns in both states and claim a credit to avoid double taxation.

Important Considerations

  • Reciprocity applies only to state income taxes and typically does not extend to local or city taxes.
  • Employees must submit the proper withholding exemption forms to employers; otherwise, state taxes may be withheld by the work state.
  • Telecommuting rules may differ; if you work entirely from your resident state, you usually owe taxes only there.

Taxpayer Tips

  • Verify whether your work and resident states have reciprocity agreements by visiting your state’s Department of Revenue website.
  • Submit exemption forms promptly to your employer to avoid unnecessary withholding.
  • If working in multiple states without agreements, prepare for multi-state filings.
  • Consider consulting a tax professional to navigate complex state tax rules effectively.

For more on related tax topics, see our articles on Tax Exemption Certificates and State Income Tax.

References

Understanding state tax reciprocity can prevent costly mistakes and double taxation for interstate workers, providing a smoother, fairer tax experience when working across state lines.