Key points about multi-state withholding and reciprocity:
- Some states have reciprocal agreements with each other to make it easier to withhold income taxes for employees who live and work in different states.
- Understanding reciprocity can make your tax filing process easier and help reduce your employees’ personal financial burden.
- Check out our Guide to Hiring an Out-of-State Employee for more information about multi-state tax and payroll compliance.
Right now, 56% of employees are working remotely at least part of the time. If you have remote employees who work and live in the same state, managing their taxes may not present that much of a challenge. But if they live in one location and work in another, figuring out their taxes can quickly become complicated.
What Is a Reciprocal Agreement?
That’s where reciprocal agreements come into play. A reciprocal agreement is a tax withholdings agreement some states have with each other to address issues that arise when employees live and work in different states. In a reciprocal agreement, both states agree to only withhold income tax for the state where the employee lives (not where they work). Reciprocal agreements are often made between neighboring states.
From an employer standpoint, reciprocity makes withholding taxes easier because you only have to withhold and report taxes for one state. From an employee standpoint, reciprocity makes filing their personal taxes easier and relieves some of their financial burden. Without reciprocity, employees would have to pay non-resident taxes to the state in which they work and resident taxes to their home state.
However, not all states allow reciprocity. Those that do have their own state-specific regulations. For instance, New Jersey only allows reciprocity with residents of Pennsylvania. However, Pennsylvania allows reciprocity with residents of Indiana, Maryland, New Jersey, Ohio, Virginia, and West Virginia.
In addition, there are nine states that do not have any income tax withholding. In this case, the withholding defaults to the state that does have withholding. The nine states without withholding are:
- New Hampshire
- South Dakota
To complicate matters even further, each state has its own form that your employee needs to complete. You also need to keep this form for your records. View a list of each state’s reciprocal agreements and forms here.
Reciprocal Agreement & Multi-State Withholding Fast Facts
Do reciprocal agreements only apply to remote employees?
No. There are many places where it’s common to live in one state and commute to an office in another. For example, a lot of people who live in New Jersey work in New York City and commute there each day. Similarly, people who live in Virginia or Maryland frequently work in Washington D.C.
Are there any special forms employees need to fill out for a reciprocal agreement?
Yes. Each state has a specific employee form for reciprocal agreements. These forms verify the employee’s place of residency and exempt them from withholding in the state where they work.
Make sure the appropriate employees complete the form for the state in which they work. For example, Michigan has a reciprocal agreement with Ohio. If you have an employee who works in Michigan, but lives in Ohio, they would complete Michigan’s reciprocal agreement form.
Keep each employee’s completed form on file for your records and comply with any additional state-specific requirements.
What happens if an employee makes a mistake on the form that verifies their state residency?
If an employee makes a mistake on their form, they may be liable for any withholding tax that might be necessary upon discovery of the issue. If you have their form on file, you will generally be safe from action against them.
What do employees need to know or do at tax time if a reciprocal agreement affects them?
As long as the state in which they work and the state where they live have a reciprocal agreement and you have withheld the appropriate state’s taxes, the employee can file their taxes as normal for their home state. If you withheld taxes for two states with a reciprocal agreement, the employee will have to file in both states and request a tax refund paid to the non-resident state.
What should an employee do if state taxes were withheld for the state in which they work and the state where they live?
If these two states have a reciprocal agreement, the employee can file a return to both states and claim a tax refund paid to the non-resident state.
If these two states do not have a reciprocal agreement, this course of action is actually correct and taxes should be withheld in both states.
What happens if an employee’s state withholding taxes are wrong?
If you accidentally withhold the wrong tax (regardless of whether there’s a reciprocal agreement), you and your employee may need to correct or amend:
- The employee’s pay history
- Any returns filed with incorrect states
- Filings to the correct states
- Form W-2 C to correct the employee’s Form W-2
Do reciprocal agreements affect Federal withholding?
No—reciprocal agreements only apply to state withholding.
Do reciprocal agreements affect any other types of multi-state withholding (such as unemployment insurance)?
In most states, no. Unemployment insurance tends to be an employer-only tax that does not affect employee income withholding. However, Alaska, New Jersey, and Pennsylvania require you to withhold state unemployment insurance (SUI) taxes from your employees’ income. If a remote employee works in one of these states, you would need to withhold the SUI taxes from their pay. In most cases, you would remit taxes to the state in which your employee works, not the state in which they live.
Easily Manage Multi-State Withholding with an HRIS
Multi-state taxation is never an easy matter. However, understanding reciprocal agreements can help you simplify withholding, reporting, and paying taxes for employees who live and work in different states.
An all-in-one HRIS like SentricHR makes it easy to manage your employees no matter where they are. With one place for employee information, benefits, and everything HR, SentricHR automatically captures changes in payroll for accurate, efficient, and compliant processing every time. Our certified tax experts will also safely and accurately handle your Federal, state, and local taxes and forms. To learn more about our Payroll and Tax Filing capabilities, schedule a demo today!
Check out our Guide to Hiring an Out-of-State Employee for more information about multi-state tax and payroll compliance.
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