State Tax Reciprocity Agreements in the United States

State Tax Reciprocity Agreements in the United States

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Introduction

While hiring remote workers from all over the world makes it easier for employers to hire premium talent, it doesn't come free of complications, as this often means having to comply with differing local tax and labor laws based on where your employees reside.

Similarly, although hiring employees in different states come with significant benefits, other states follow different procedures for proper withholdings and tax laws. Your HR team and payroll managers must familiarize themselves with the tax laws in the states where remote employees reside.

Fortunately, hiring employees living in different states can be simple, and state tax reciprocity agreements make it reasonably simple. Continue reading to learn what a state tax reciprocity agreement is. Also, discover which states have reciprocity agreements and what you need to know when hiring employees in different states.

What is a state tax reciprocity agreement?

A state tax reciprocity agreement entitles individuals who live in one state and work in another to only pay income tax for the state where they live. While this once applied most commonly to individuals living near state borders who would commute from their home state to work in a different state, the practice is significantly more common as remote working has become commonplace.

When hiring individuals who live in a different state than where your business is located, you should check and see if the prospective employee's state of residence has a reciprocity agreement with your state. If it does, you must withhold state taxes according to the employee's home state.

State-issued certificates stating that employees are exempt from having taxes withheld in the state where they work are required, and you will need to ensure this paperwork is filed before you begin paying your new employee.

If no reciprocity agreement exists, then you can withhold taxes just as you would for employees who live in your state, and the employee can then apply for a tax credit when filing their taxes.

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States with reciprocal tax agreements

There are currently 17 states with reciprocity agreements. Some reciprocity states only have an agreement with a single neighboring state, while others have agreements with multiple other states.

It's important to note that reciprocity agreements only go one way. For example, Arizona has a reciprocity agreement with Indiana; if your business is located in Arizona and you hire an employee who lives in Indiana, you can withhold taxes according to Indiana state law and exempt the employee from Arizona withholdings.

However, Indiana does not have a reciprocity agreement with Arizona, so the same rules don't apply when the employee's residence and the business location are reversed.

Below is a list of the 17 reciprocity agreement states, the states they have agreements with, and which forms your business will need to ensure are filed to consider an employee exempt from state withholdings.

Arizona

Arizona has reciprocity agreements with Indiana, California, Virginia, and Oregon. Employees living in one of these states should file the Withholding Exemption Certificate ( Form WEC).

Illinois

Illinois has reciprocity agreements with Kentucky, Wisconsin, Michigan, and Iowa. Employees living in one of these states should file the Employee’s Statement of Nonresidence in Illinois ( Form IL-W-5-NR).

Indiana

Indiana has reciprocity agreements with Kentucky, Wisconsin, Michigan, Pennsylvania, and Ohio. Employees living in one of these states should file the Certificate Residence ( Form WH-47).

Iowa

The only state that Iowa has a reciprocity agreement with is Illinois. Employees living in Illinois should file the Employee’s Statement of Nonresidence in Iowa ( Form 44-016).

Kentucky

Indiana has reciprocity agreements with West Virginia, Wisconsin, Michigan, Indiana, Illinois, Virginia, and Ohio. Employees living in one of these states should file the Certificate of Nonresidence ( Form 42A809).

Maryland

Maryland has reciprocity agreements with West Virginia, Pennsylvania, Virginia, and Washington, D.C. Employees, living in one of these states should file exemption Form MW 507.

Michigan

Michigan has reciprocity agreements with Kentucky, Wisconsin, Indiana, Illinois, Minnesota, and Ohio. Employees living in one of these states should file the Employee's Michigan Withholding Exemption Certificate ( Form MI-W4).

Minnesota

Minnesota has reciprocity agreements with North Dakota and Michigan. Employees in one of these states should file the Reciprocity Exemption/Affidavit of Residency ( Form MWR).

Montana

The only state that Montana has a reciprocity agreement with is North Dakota. Employees living in North Dakota should file the Montana Employee’s Withholding Allowance and Exemption Certificate ( Form MW-4).

New Jersey

The only state that New Jersey has a reciprocity agreement with is Pennsylvania. Employees living in Pennsylvania should file the Employee’s Certificate of Nonresidence In New Jersey ( Form NJ-165).

North Dakota

North Dakota has reciprocity agreements with Montana and Minnesota. Employees in one of these states should file the Reciprocity exemption from withholding for qualifying Minnesota and Montana residents working in North Dakota ( Form NDW-R).

Ohio

Ohio has reciprocity agreements with Indiana, Pennsylvania, Kentucky, West Virginia, and Michigan. Employees living in one of these states should file the Statement of Residency ( Form IT-4NR).

Pennsylvania

Pennsylvania has reciprocity agreements with Indiana, New Jersey, Maryland, West Virginia, Ohio, and Virginia. Employees living in one of these states should file the Employee's Nonwithholding Application Certificate ( Form REV-419).

Virginia

Virginia has reciprocity agreements with Pennsylvania, Washington, D.C., Kentucky, Maryland, and West Virginia. Employees living in one of these states should file the Employee's Virginia Income Tax Withholding Exemption Certificate ( Form VA-4).

Washington, D.C.

Washington, D.C., is unique because everyone working in the District of Columbia is eligible for income tax withholding exemption. Individuals who work in Washington, D.C., should file the Certificate of Nonresidence in the District of Columbia ( Form D-4A).

West Virginia

West Virginia has reciprocity agreements with Pennsylvania, Ohio, Kentucky, Maryland, and Virginia. Employees living in one of these states should file the West Virginia Employee Withholding Exemption Certificate ( Form WV/IT-104).

Wisconsin

Wisconsin has reciprocity agreements with Indiana, Illinois, Kentucky, and Michigan. Employees living in one of these states should file the Nonresident Employee's Withholding Reciprocity Declaration ( Form W-220).

What do companies need to know?

Your company is responsible for compliantly withholding employee taxes, which means you will need to be aware of local tax laws in the state where your employees reside.

If you want to keep things as simple as possible, you can stick to hiring employees who currently reside in your business' state or states that have reciprocity agreements with your state.

However, employees residing in states that don't have reciprocity agreements with your state will have their taxes withheld per your state's tax laws. Any mishandling of employee withholdings may result in an audit from the IRS, which could cost you a significant amount in back pay or back taxes.

If you're hiring out-of-state employees for the first time or are trying to figure out how to grow your team to new states, consider partnering with a staffing solution to ensure your company remains compliant with all relevant tax and labor laws.

Compliantly build your remote team with Skuad

Managing payroll is a complicated task. And it can become overwhelming for internal HR teams to drive growth and employee payroll in new states and countries; you may need to consult professional guidance if you hire more than one out-of-state employee.

Noncompliance with tax and labor laws can carry significant financial consequences for your company, reducing your ability to operate and expand effectively.

By partnering with a global employment and payroll platform like Skuad, you can ensure that your company remains compliant with all relevant tax and labor laws in the states and countries you expand to. This effective compliance will allow you to focus on managing your team and growing your business.

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