Daniel Bunn President and CEO at Tax Foundation | Twitter Website
A tax reciprocity agreement is a pact between two or more states that prevents the taxation of income for workers who commute from one state to another. This arrangement simplifies tax compliance for commuters, as they are only required to file taxes in their state of residence.
When individuals live in one state and work in another, they may face tax liabilities in both states. To avoid double taxation, home states typically provide a tax credit. Tax reciprocity agreements further ease the process by allowing taxpayers to adhere solely to their home state's income tax code.
An example involves a Virginia resident working in Washington D.C., where a reciprocity agreement exists. The taxpayer incurs tax liability only in Virginia and can disregard D.C.'s income tax requirements.
Conversely, five states impose taxes based on the location of the office rather than where work is performed. These states may deny credits for taxes paid elsewhere, leading to double taxation under what is known as the "convenience rule." Massachusetts had adopted such a rule during the pandemic but has since allowed it to expire. Arkansas repealed its rule, leaving New York, Connecticut, Delaware, Nebraska, and Pennsylvania with active convenience rules.
Without these rules, living and working across state lines does not usually result in double taxation but requires filing taxes in multiple states. This can increase compliance costs significantly.
The rise of hybrid work arrangements complicates matters further for those commuting across state lines. Reciprocity agreements simplify this by allowing taxpayers to file with just one state.
Several states have entered into reciprocity agreements including Illinois, Indiana, Iowa, Kentucky, Maryland, Michigan, Minnesota, Montana, New Jersey, North Dakota, Ohio, Pennsylvania, Virginia, West Virginia, Wisconsin and Washington D.C.
Sources include state statutes and regulations along with research from Bloomberg Tax and the Tax Foundation.
