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What Is a Reciprocal Tax Agreement and How Does It Work?

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Feb. 4 2022, Published 2:18 p.m. ET

The COVID-19 pandemic created a requirement for remote work and it encouraged some people to move to less expensive states. With tax season upon us, people working in one state and residing in another should consider how they will file their taxes. What is a reciprocal tax agreement and how does it work?

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A state reciprocal agreement is one between two states that provides residents the opportunity to request an exemption from tax withholding in the reciprocal state. When permitted, it saves residents the trouble of filing for multiple state returns. A tax reciprocal agreement is ideal for people who live in one state and work in another. Completing a tax agreement means that the taxpayer won't have tax withheld in their state of employment. Note that resident state taxes need to be withheld.

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How do tax reciprocal tax agreements work?

Currently, 18 states have reciprocal agreements with other states. Here’s a close look at five of them. If someone works in Washington, D.C. and they reside in any other state, they don't have to file a tax return. However, they need to submit an exemption form D-4A, which is the “Certificate of Nonresidence in the District of Colombia” to their employer. The agreement only works in reverse for Maryland and Virginia. If you live in either of these states and work in Washington, D.C. you don't have to file a non-resident return.

Iowa has a reciprocity agreement with Illinois. If a person works in Iowa but is a resident in Illinois, Iowa state income tax doesn’t need to be held by the taxpayer’s employer. They would need to submit Form 44-016 to their place of employment.

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Seven states have a reciprocal agreement with Kentucky—Illinois, Indiana, Michigan, Ohio, Virginia, West Virginia, and Wisconsin. People residing in any of the seven states, while working in Kentucky, will need to complete exemption Form 42A809 with their employer. Note that Virginia residents have to commute daily to be eligible and Ohio residents can't be shareholders of 20 percent or greater in an S corporation.

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Michigan has a reciprocal agreement with the following states—Indiana, Illinois, Kentucky, Ohio, Minnesota, and Wisconsin. Those working in Michigan while residing in the previously mentioned states need to file Form MI-W4 with their employer.

Lastly, Pennsylvania employees can file for a reciprocal tax agreement with Maryland, Indiana, New Jersey, West Virginia, and Ohio using form REV-419.

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What about states that don't have a reciprocal agreement?

People working in a state that doesn’t have a reciprocal agreement with their resident state don’t have to pay taxes twice, but they will have to file multiple state tax returns. When a reciprocity tax agreement isn’t available, employers withhold state income taxes for the state of employment. There are instances where instead of taxing double the amount, the state in question might offer credit for the amount that was withheld in their state of employment.

Keep in mind that tax rates differ from state to state. For example, if the state of employment has a lower rate than the state of residency, the individual will pay slightly more to the state of residency during tax season. However, if the work state has a greater income tax rate than the state of residency, they will need to wait for a refund.

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