State reciprocity agreements: Complete guide

In the United States, all employees are subject to federal taxes regardless of their state of residence. State income taxes are a different story. 

An employee who lives in one state but works at a company based in another may not have to pay state taxes where they work. If there’s a reciprocal agreement in place, they only have to pay taxes in their resident state. Multiple states have such reciprocity agreements with different rules, while many states do not allow state tax reciprocity at all. 

This guide will unpack how reciprocity agreements work, their different rules across states, and best practices to comply with varying tax regulations. 

What is a reciprocal agreement between states? 

State reciprocity agreements refer to pacts between two or more states that allow employees who live in one state and work in one of the others to only pay state income tax in their home state.  

This means that for states with reciprocal agreements, an employee who is a resident in one state and crosses a state line to work in a reciprocal state pays state income tax only to their resident state. The employee is also exempt from filing a non-resident tax return in the state where they work. This reciprocal agreement applies only to state income taxes. 

State tax reciprocal agreements make it easier for employees to file state income tax returns. For employers, withholding taxes is simpler because they only need to withhold state and local taxes for the employee’s home state. 

There are two kinds of state tax reciprocity agreements:

1. Bilateral agreements: This is a reciprocity agreement between two states in which both states agree to provide tax credits or exemptions to residents of the other state. For example, if a Maryland resident works in Pennsylvania, they would not have to pay state taxes in Pennsylvania because the two states have a bilateral tax reciprocity agreement. Multiple states have bilateral state tax reciprocity agreements. In fact, most of the reciprocal agreements that currently exist in the United States are bilateral agreements but the details vary from state to state. 
2. Unilateral agreements: This is a state tax reciprocity agreement that allows one state to decide how it treats the income of its residents who earn money in other states without requiring the other states to agree. For instance, Indiana, Minnesota, and Wisconsin have unilateral reciprocity agreements which automatically extend state tax reciprocity to any state that offers a similar tax arrangement to their residents.

4 Benefits of state reciprocity agreements for employers

1. Simplified payroll: Employers can simply adjust payroll to withhold state taxes based on the employee’s home state rather than the state where they work, which reduces payroll complexity and opportunities for errors. 
2. Easier remote hiring: The rise of remote work and flexible job locations has made it more common for employers to hire out of state employees. State tax reciprocity agreements make it easier to hire employees who reside in different states because it simplifies tax withholdings.  
3. Easy compliance with state tax laws: Reciprocity agreements allow employers to only withhold state income taxes for one jurisdiction. State taxes are only paid in the employee’s home state if a reciprocal agreement is in place. 
4. Access to larger talent pool: Top talent is more likely to accept job offers in a different state if candidates know they won’t be burdened with complex tax returns, tax credit processes, and double taxation. This enables an employer to attract diverse candidates from different states and fill roles more quickly.

What should I do if my company is in a state without state tax reciprocity? 

Employees who work remotely or in a different state from where they live often don’t know about reciprocity rules, or whether they're covered by a state tax reciprocity agreement. This can lead to confusion about nonresident status and how to pay state taxes, concern about double taxation, and unexpected expenses when filing state tax returns. Employers should let their employees know upfront about state tax reciprocity so they can be prepared when it comes time to pay state income taxes.

If there is no tax reciprocity agreement, employers may need to withhold taxes for both the employee’s home state and the state where the business is located. Each state has different requirements for income tax so it may necessitate researching the tax laws in the employee’s home state. An employer should send their employees the appropriate tax forms at the end of the year so they can file their state tax returns accurately. Also, they should investigate if employees are eligible for income tax credits for state taxes paid to offset double taxation. 

Keep in mind that employees don’t have to be concerned about having to pay all the taxes for both states. Employees who work in states that don’t have reciprocal agreements are protected by federal law, which prohibits multiple states from charging state taxes on the same income. Despite this ruling, it can still cause headaches for employees when they file taxes. Luckily, most states grant a tax credit or a tax refund to cover the cost of being taxed twice, mitigating the risk of double taxation. 

3 reciprocity agreement best practices for employers

1. Ensure correct withholding: Make sure to withhold the right amount of state taxes for each employee based on their residence and whether or not there is a reciprocity agreement in place. This also applies to international employers with employees who live in the US.
2. Educate employees on filing requirements: Employers should let their employees know ahead of time whether they’re covered by a state tax reciprocity agreement. This way, they can be ready when it’s time to file state income tax returns and submit the proper tax forms for their states. 
3. Keep accurate business records: Companies may have to register their business with both the employee’s work and home states. 

Rippling: Accurate payroll for your remote employees

Rippling’s full-service payroll software streamlines and automates payroll to save companies time and money. For instance, Rippling calculates all taxes and submits tax forms and payments automatically. Employee withholdings automatically flow into payroll, so there’s no need to manually enter withholding amounts. And electronic copies of employee tax forms are stored for reference or audit purposes. And they’re all attached to an employee’s profile—even after termination—so they’re easy to locate at any time. 

Rippling comes preconfigured to support remote employees, so when you set a new hire's status to “remote,” Rippling will automatically use their home address for taxes in payroll, and will handle registering for and maintaining your state and local payroll tax accounts. Everything from hours worked to tax deductions are automatically calculated when running payroll. Plus, your team will have the peace of mind that you’re complying with all the necessary regulations for the tax jurisdictions you’re operating in. 

Reciprocity agreement FAQs

Which states have a reciprocity agreement with Texas? 

Texas doesn’t have a tax reciprocity agreement with any states.

Does California have a reciprocity agreement with Arizona? 

Yes, Arizona has state tax reciprocity agreements with California, Indiana, Oregon, and Virginia, which allows nonresidents of Arizona who reside in these reciprocal states to only pay taxes in their state of residence. 

How can employees apply for reciprocity exemptions? 

For states with reciprocal agreements, an employee would use the tax forms designated by the state of their employer according to the chart designating state reciprocity above. 

Does reciprocity apply to all types of income? 

Reciprocity rules differ from state to state. Some reciprocity agreements apply to all income, while others are restricted to certain classes of income—usually wage and compensation income.

This blog is based on information available to Rippling as of October 29, 2024.

Disclaimer: Rippling and its affiliates do not provide tax, accounting, or legal advice. This material has been prepared for informational purposes only, and is not intended to provide or be relied on for tax, accounting, or legal advice. You should consult your own tax, accounting, and legal advisors before engaging in any related activities or transactions.