What is state income tax exchange?

Definition:

State income tax reciprocity refers to an agreement between two or more states that they will exempt from taxation income earned by workers who work in one state and live in another. These agreements allow residents of one state to work across state lines and pay income taxes only to their state of residence.

How does state income tax reciprocity work?

If you work in one state and live in a reciprocal state, you can submit an exemption certificate to your employer. This will allow you to avoid paying income tax in the state where you work. However, this does not mean you are not responsible for any state income tax. Your employer should withhold your residence state’s taxes instead since you will owe them.

Some states may require you to pay estimated taxes to your residence state yourself. Your employer will not withhold any taxes for other states and send them to that state, even if they have a reciprocity agreement. You still remain solely responsible for ensuring your residence state is paid.

Note: Reciprocity agreements typically cover only earned income. Earned income includes wages, salary, tips, and commissions. It usually does not apply to other sources of income such as interest, lottery winnings, capital gains, or any money not earned through work.

You may need to file a second tax return to claim a refund of incorrectly withheld taxes. For example, if you live in Illinois and work in another state that has a reciprocity agreement with Illinois, your employer may incorrectly withhold state tax from your paycheck for the state where you work. In this case, you will need to file a tax return from your employer’s state to recover that money.

Reciprocity does not affect taxes or tax withholdings paid to the Internal Revenue Service (IRS). The IRS does not care what state you live in or where you earn your income. If you have earned income in the United States, the IRS wants its share.

If you wish to claim a tax exemption in your work state, you will need to inform your employer. This is typically done by submitting a form. You will likely need to provide your work state exemption certificate to your employer.

You may need to show proof of residency. Your human resources department should be able to tell you what forms to fill out and what documentation to submit.

Note: You may be able to find the correct forms through your work state’s tax authority website.

Example of reciprocity

For example, you will file an income tax return in Virginia at the end of the year if you live there but work in Washington, D.C. You will not need to file an income tax return in Washington, D.C. because it has a reciprocity agreement with all other states. This saves you the hassle of filing two separate tax returns, which you would need if there were no reciprocity agreement between the two states.

However, even if you are not covered by a reciprocity agreement, you will not have to pay taxes to two different entities on the same income. The U.S. Supreme Court ruled in Maryland v. Wynne that employees should not have to pay local and state income taxes to two different entities on the same income.

Nonetheless, the reciprocity agreement makes determining which state you owe taxes to much simpler. It can save you time and money:

• Time:
• You will not need to file two returns.
• Money: You won’t accidentally pay taxes in more than one state.

Which states have reciprocity agreements?

Check the map below to see the reciprocity agreements between states. Living in any of the states covered by a reciprocity agreement means your taxes won’t be withheld from your paycheck automatically.

The U.S. Supreme Court decision in the Maryland vs. Wynne case applies to all states, not just Maryland, although Maryland was the original plaintiff. The court ruled that no two taxing authorities can impose a tax on the same income. Accordingly, you should not have to pay income taxes to both your work state and your residence state, even if they do not have reciprocity agreements in place.

Note: Reciprocity agreements only provide for the non-withholding of taxes for the work state from your wages, but you will not be taxed twice even if so.

Most states have amended this ruling by providing tax credits for what you paid to your work state. However, you will need to file tax returns to claim the credits each year.

Small business owners may not be aware of this rule. Contact the revenue department or the state’s treasurer if your employer is unsure or insists on withholding taxes from your paycheck.

Frequently Asked Questions

What is a state tax reciprocity form?

State tax reciprocity forms are provided to be exempt from state income tax in the state where you work so that taxes are imposed in the state where you live. You may need to submit the forms to your employer. Your employer may provide these forms, but you should also be able to find the correct forms through your work state’s tax authority website.

How do I apply for tax reciprocity in another state?

Typically, you must inform your employer to claim an exemption from withholding. Your employer may require a certificate issued by the state, which they may provide or may be available online.

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Sources:

The Balance only uses high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we fact-check and maintain our content’s accuracy, reliability, and quality.

Illinois Department of Revenue. “What if I live or work in a state that has a reciprocity agreement with Illinois?” Accessed January 23, 2022.

American Bar Association. “Wynne is a win for most state taxpayers.” The Supreme Court of the United States. “The Supreme Court of the United States: Maryland State Comptroller v. Wynne,” pages 4-5.

Source: https://www.thebalancemoney.com/what-is-reciprocity-for-state-income-tax-3193330