Employing workers in multiple states or across state lines creates additional challenges for payroll departments. Among those challenges are reciprocal tax agreements. Such agreements determine how much in state income taxes is withheld and paid on behalf of affected employees.
Reciprocal tax agreements are not difficult to understand in principle. In practice however, such agreements can be confusing. Employers affected by these agreements have to have key people in place who understand how they work. Failing to honor a reciprocal tax agreement could lead to trouble at tax time.
The point of this post is to familiarize you with reciprocal tax agreements. If your company is affected by one or more of them, your payroll department really needs to stay up to speed. Better yet, consider outsourcing your payroll to BenefitMall. Let us worry about reciprocal tax agreements for you.
A Concise Definition
A reciprocal tax agreement between states is an agreement that allows residents to request exemption from income tax in two states, when they live in one state and work in another. It is a form of tax reciprocity that is governed by state laws. State reciprocity does not apply between states that have no agreements between them.
Practically speaking, let us say you own a company located very near the border between Illinois and Wisconsin. As such, you have Wisconsin residents crossing into Illinois to work every day. The reciprocal tax agreement between the two states exempts the cross-border employee from having to pay taxes in both states.
The employer would withhold and report taxes for that employee based on Wisconsin residency. The employee would be exempt from taxation in Illinois.
Reciprocal tax agreements are pretty straightforward. Where things get tricky is in the implementation of such agreements. All the states that have reciprocal agreements have some sort of form employees need to fill out. Forms for individual states can differ substantially based on state laws.
In principle, implementing a reciprocal tax agreement would be as simple as having the employee fill out and submit the appropriate form. With that form on file, the employer is free to exempt that employee from state withholding and reporting in the non-resident state. However, the employer does have certain obligations in terms of reporting that exemption to the state in which it is located.
Below is a sample list of a few states and those they have reciprocal tax agreements with. Note that this list is by no means conclusive.
• Illinois reciprocates with: Iowa, Kentucky, Michigan, and Wisconsin.
• Wisconsin reciprocates with: Illinois, Indiana, Kentucky, and Michigan.
• Minnesota reciprocates with: Michigan and North Dakota.
• North Dakota reciprocates with: Minnesota and Montana.
In the event an employer applies reciprocity the wrong way – i.e., it withholds and pays taxes in the work state rather than the resident state – the employee will have to file a form at the end of the tax year for both states. The form filed with the work state is to request a refund while the form filed with the resident state is to report and pay taxes.
Does your company employ workers across state lines? If so, they may be eligible to take advantage of reciprocal tax agreements. Have your company accountant or tax professional look into it. If such an agreement applies in your case, it will save your cross-border employees from double taxation.
As always, you can contact BenefitMall to learn more about our cloud-based payroll solutions. Outsourcing your payroll to us relieves you of the responsibility of having to worry about tax reciprocity.