Wage Withholding Wisdom: Income Tax Reciprocity Can Ease Withholding Woes But Varies by State

When withholding taxes for employees who work in one state but live in another, employers should be careful to examine the states’ relationships.  Reciprocity agreements are often made between neighboring states and can make withholding easier for employees and employers because resident and nonresident taxation does not have to be determined.

Reciprocity  agreements between states allow employers to withhold for the state of residence instead of the state in which services are performed. However, state  reciprocity  agreements do not apply to local taxes.

Such agreements are entered into by two or more states so that the resident of one state working in another will not be subject to withholding taxes by the state where the worker is employed, as long as that state has a similar agreement with the employee's resident state. Generally, nonresident employees certify that they will be exempt from income tax in the state where they are employed because of their tax liability in their state of residence.

These jurisdictions have reciprocal agreements with other states: Illinois, Indiana, Iowa, Kentucky, Maryland, Michigan, Minnesota, Montana, New Jersey, North Dakota, Ohio, Pennsylvania, Virginia, West Virginia, Wisconsin and the District of Columbia.

The implementation of reciprocity among states can differ from state to state. Some states, such as California, do not have official reciprocity agreements with other states, but allow some nonresident employees to take a credit toward their California income tax liability for taxes paid to their home state.

Other states, such as Colorado, allow their residents that work in other states to be excused from Colorado withholding on wages from which income tax is withheld for the other jurisdiction. Still other states, such as Minnesota and Wisconsin, have struggled in establishing and maintaining reciprocity agreements that satisfy both jurisdictions.

On May 20, 2014, Minnesota Gov. Mark Dayton (DFL) signed legislation (H.B. 3167) that could lead Minnesota to reestablish the reciprocity agreement with Wisconsin. However, on July 24, after Wisconsin proposed a reciprocal agreement, Minnesota rejected it, arguing that the agreement does not compensate Minnesota for the nearly $6 million that it loses in revenue annually to Wisconsin.

Minnesota and Wisconsin have not had a reciprocal agreement since Jan. 1, 2010, and legislators have been working on restoring this relationship.  The end of the reciprocity agreement affected about 57,000 Wisconsin residents and 22,000 Minnesota residents, according to the Wisconsin Department of Revenue.

For more information on state-by-state reciprocity, see the Payroll Administration Guide.

 By Allison M. Gatrone