How do state reciprocity agreements change withholding for cross-border workers?

State reciprocity agreements alter payroll withholding by shifting income-tax withholding responsibility from the state where you work to the state where you live, provided you meet the agreement’s rules. For eligible employees this usually means completing a state reciprocal withholding exemption form and giving it to your employer so payroll withholds taxes for your home state only. If done correctly, you avoid routine nonresident withholding and – in many cases – avoid filing a nonresident return in the work state.

Below I explain how the agreements operate, who benefits, common pitfalls, real-world steps to correct mistakes, and where to check for the definitive rules in 2025.

How reciprocal withholding typically works

  • Employee eligibility: Reciprocity generally applies to wage and salary income earned by employees who live in one state and commute to another. It usually does not apply to business income, self-employment income, or some special-pay types (commissions, nonwage compensation) unless the state agreement explicitly covers them.

  • Employee action: To stop withholding by the work state, the employee submits a reciprocal withholding exemption certificate (or similar form) to the employer. The exact name and form vary by state; check your state revenue department or your employer’s payroll team.

  • Employer action: Once the employer receives the valid residence exemption, payroll should stop withholding the work-state income tax and withhold only for the employee’s residency state. If the employer withholds the wrong state tax, the employee can request payroll corrections and, if necessary, claim a refund from the wrong state or claim credit on their residence-state return.

  • Filing outcome: With reciprocity in place you normally file a single resident return in your home state. You may still need to file in the work state in limited cases (for nonwage items, to recover withheld amounts, or to claim credits), so verify the rules for both jurisdictions.

Sources: IRS (general withholding guidance) and state revenue departments; see IRS Tax Topic 505 for withholding basics (IRS.gov/taxtopics/tc505).

Who benefits — and who doesn’t

  • Employees who typically benefit: Regular commuters whose primary income is wages or salary and whose states have an active reciprocal agreement. The main advantage is simpler filing and less paperwork.

  • Employees who often are excluded: Self-employed people, independent contractors, gig workers, and those with significant nonwage income usually remain subject to apportionment or nonresident filing rules. Some agreements also exclude certain payments (like withholding on bonuses or commissions).

  • Employers: A correct reciprocal exemption reduces payroll complexity and lowers the number of states where the employer must withhold and remit taxes for that employee.

In my practice advising cross-border workers, I’ve seen the greatest benefit for daily commuters in metropolitan border regions where wages are almost entirely wage-and-salary based.

Common mistakes and how to avoid them

  1. Assuming reciprocity exists: Not all neighboring states have reciprocity. Always confirm current agreements with the state revenue agencies. (State rules change sometimes; check updated guidance.)

  2. Failing to submit the right form: Employees must file whatever reciprocal withholding exemption their states require. Without it, the employer will likely withhold for the work state.

  3. Ignoring local taxes: City or municipal taxes (for example, local earned-income taxes or commuter levies) may still apply even where state reciprocity prevents state withholding.

  4. Overlooking nonwage income: Reciprocity typically covers wages. You may still need to file and pay tax on nonwage income in the state where it’s generated.

  5. Not tracking remote work days: Post-2020 telework practices complicate residency and sourcing rules. If you telecommute from your residence rather than commute, the work-state may not have a withholding claim — but rules vary.

Real-world corrective steps if withholding is wrong

  1. Talk to payroll immediately. Provide proof of residence and the required reciprocal exemption form. Employers can often stop future incorrect withholding once they have documentation.

  2. Request payroll corrections. If the wrong state was withheld in prior pay periods, ask payroll for corrected wage statements (W-2c) and a refund of taxes remitted in error.

  3. File a refund claim with the nonresident (work) state if payroll does not voluntarily correct past withholding. States have procedures for refunding improperly withheld taxes; timelines and forms vary.

  4. Use your residency return to claim credit. If you paid tax to the working state in error and cannot get an immediate refund, your home state’s resident return often allows a credit or deduction for taxes paid to other jurisdictions. Document everything carefully.

  5. Keep records. Save pay stubs, correspondence with payroll, exemption forms, and any state forms you submit.

If you need to amend federal or state returns in response to corrected wages or withholding, consider Form W-2c for wage corrections and consult a tax preparer before filing amended returns.

Practical examples (illustrative)

  • Example A (commuter employee): Jane lives in State R and works in State W. R and W have a reciprocity agreement for wage income. Jane files the residence exemption with her employer in State W; payroll withholds State R taxes only. At tax time Jane files a resident return in State R and usually does not file a nonresident return in State W.

  • Example B (self-employed or mixed income): Mark lives in State R but performs contract work in State W that is paid as nonemployee compensation. Reciprocity for wages does not apply to self-employment income, so Mark must review work-state sourcing rules and may need to file a nonresident return for the income earned there.

Note: The examples are illustrative; always check the specific state rules.

How to confirm whether an agreement applies to you (step-by-step)

  1. Check your home-state revenue department website for a list of reciprocal agreements and required forms.
  2. Check the work-state revenue department for reciprocal exemption forms and withholding instructions.
  3. Ask your employer payroll or HR for the specific reciprocal form they accept.
  4. If you’re unsure, consult a CPA or state tax specialist — especially if you have nonwage income or telework days.

For a primer on reciprocity and how it interacts with telecommuting and multistate withholding, see our related articles on State tax reciprocity and How State Income Tax Withholding Works When You Work in Multiple States. Employers should also review State Withholding Nuances for Telecommuters: Reciprocity, Credits, and Remedies for payroll compliance considerations.

What to watch for in 2025

  • Telework and nexus changes: Post-pandemic telework arrangements have prompted states to update guidance on sourcing income and withholding. Some states issue temporary or permanent rules on when remote days create employer withholding obligations.

  • Forms and process changes: States occasionally update the names or filing procedures for reciprocal exemption certificates. Always use the current form published by the revenue department.

  • Local taxes: Cities and municipalities continue to set and enforce local payroll taxes that may not be affected by reciprocity, so confirm local rules before assuming no local withholding.

Professional takeaways

  • For most eligible commuters, a properly submitted reciprocal withholding exemption simplifies payroll and reduces the need to file a nonresident return.

  • Self-employed individuals and those with mixed income frequently still face multistate filing obligations even when wage reciprocity exists.

  • Quick action and clear documentation make correcting wrong withholding far easier than waiting until tax season.

In my years advising commuters and employers, I’ve seen that establishing the correct withholding setup early in the year prevents most headaches. When payroll and employee residency records match the state rules, both parties save time and reduce audit risk.

Authoritative resources and next steps

  • IRS — Tax Topic 505: Withholding and Estimated Tax (https://www.irs.gov/taxtopics/tc505) — general federal withholding guidance and links to state resources.
  • Your state revenue department — search for “reciprocal withholding” or “reciprocity agreement” on the state site for the current form and instructions.
  • Tax Policy Center and state-specific tax guidance for broader policy context (https://www.taxpolicycenter.org).

Professional disclaimer: This article is educational and does not provide individualized tax advice. State tax laws and reciprocity rules change; consult a qualified CPA or state tax official for guidance tailored to your situation.