What Is Tax Reciprocity and What Does It Mean for Your Small Business?

Tax season never really sneaks up on business owners. Year-end planning can take months of reviewing records, filing numerous forms, and adhering to compliance regulations. For small businesses with employees crossing state lines to work (physically or virtually), tax reciprocity can add another layer of confusion.

The good news is that reciprocity agreements can simplify life for your people and reduce the tax administration headaches for you. 

Below we discuss what tax reciprocity means, which states are involved, and how it impacts your small business in 2026 and beyond.

What Is Tax Reciprocity?

If you have employees who live in one state but work in another, reciprocity agreements may apply. For example, if your business is in Pennsylvania and your employee lives in New Jersey, that worker might qualify to pay income tax only in their home state.

Put simply: Tax reciprocity allows employees to avoid double taxation at the state level. Instead of filing returns in both states, they only file in their state of residence.

A few quick notes:

• Reciprocity applies to state income tax, not federal or other state and local payroll taxes.
• Employees must usually submit a specific exemption form to you, the employer, so you can withhold correctly.
• Without that form, you’re required to withhold tax for the state where the work is performed.

What Is a Reciprocal State?

A reciprocal state is simply a state that has an agreement with a neighboring state to recognize each other’s residents for income tax purposes.

Employees benefit by filing just one state tax return, and employers benefit by knowing exactly which state’s withholding applies. For example, New Jersey and Pennsylvania have a reciprocal agreement. That means a New Jersey resident working in Pennsylvania only pays income tax to New Jersey, not both states.

States With Tax Reciprocity in 2026

These are the states (plus Washington, D.C.) that currently have reciprocity agreements, the states they have agreements with, and the required exemption or non-residency form employees must file.

Work State	States with Reciprocal Agreements (Home/Resident State)	Required Employee Exemption/Non-Residency Form
Arizona	California; Indiana; Oregon; Virginia	Form WEC
District of Columbia	Any non-residents who work in DC	Form D-4A
Illinois	Iowa; Kentucky; Michigan; Wisconsin	Form IL-W-5-NR
Indiana	Kentucky; Michigan; Ohio; Pennsylvania; Wisconsin	Form WH-47
Iowa	Illinois	Form 44-016
Kentucky	Illinois; Indiana; Michigan; Ohio; Virginia; West Virginia; Wisconsin	Form 42A809
Maryland	Pennsylvania; Virginia; Washington D.C; West Virginia	Form MW 507
Michigan	Illinois; Indiana; Kentucky; Minnesota; Ohio; Wisconsin	Form MI-W4
Minnesota	Michigan; North Dakota	Form MWR
Montana	North Dakota	Form NR-2
New Jersey	Pennsylvania	Form NJ-165
North Dakota	Minnesota; Montana	Form NDW-R
Ohio	Indiana; Kentucky; Michigan; Pennsylvania; West Virginia	Form IT-4NR
Pennsylvania	Indiana; Maryland; New Jersey; Ohio; Virginia; West Virginia	Form REV-420
Virginia	Kentucky; Maryland; Pennsylvania; Washington, D.C.; West Virginia	Form VA-4
West Virginia	Kentucky; Maryland; Ohio; Pennsylvania; Virginia	Form WV/IT-104
Wisconsin	Illinois; Indiana; Kentucky; Michigan	Form W-220

What Small Businesses Need to Know 

Businesses of every size adhere to tax reciprocity, but staying compliant can be extra challenging if you’re a small business with limited staff. That’s one reason why planning benefits small companies: there will be less stress and asking Where’s that paper, again? come tax season.

Below are ten strategies to use so your filing is error-free. 

1. Onboard properly. When you hire someone who lives in a different state, part of your onboarding checklist should include figuring out whether reciprocity applies. Ask where they live and where they work, then check the chart above.
   
2. Get the right exemption/non-residency form early. The employee must submit the proper form before you can stop withholding state tax for the work state. If you don’t have the form, you keep withholding as though there’s no reciprocity.
   
3. Register for withholding in the resident state if needed. Sometimes, if you’re withholding based on the employee’s state of residence, you’ll need to register with that state (you might need a withholding account there). If you don’t, there could be penalties or uncollected taxes.
   
4. Keep accurate records. Maintain copies of exemption or non-residency certificates. Track changes in residency or work location. If someone moves across state lines or starts working remotely, that might change which state’s tax rules apply. Good documentation helps with audits or resolving employee questions.
   
5. Be aware that remote and hybrid work adds complexity. With more employees splitting time between home and office (or working fully remote across state lines), state tax laws are adapting. Some states count work performed physically in the work state even if the person lives elsewhere; others look at the number of days in a non-resident state to trigger withholding. Stay current with the states where your employees live or report to.
   
6. Watch for conditional rules or exceptions. Some reciprocity agreements have special conditions. Examples:
   • In Kentucky, certain residency or commuting conditions may apply.
   • Ownership stakes (like being a major shareholder) may trigger different withholding rules in some agreements.
     
7. Communicate clearly with your employees. Many confusion points come from employees not realizing they need to fill out a form, or that their residency/work location changed. Clear directions during onboarding (and reminders) help avoid over-withholding, employee frustration, or correction work later.
   
8. Plan payroll systems for flexibility. Make sure your payroll software or provider can handle multiple state withholding settings, track exemption forms, and adapt if an employee changes states.
   
9. Consult with tax / payroll experts periodically. Sometimes tax reciprocity agreements are amended, or a state adjusts what counts as “working” in a state for withholding purposes (e.g. remote days). Checking in with a CPA or payroll specialist once a year (or whenever you have cross-state changes) is smart.
   
10. Note when no reciprocity exists. If there is no agreement between the state where an employee lives and the state where they work, you’ll likely have to withhold income tax in the work state. The employee will have to file tax returns in both states (resident state and nonresident work state) and may be eligible for credits in their home state for taxes paid elsewhere.
    

Navigate Payroll Taxes With Ease

Tax season is usually a stressful time of year, but that doesn’t mean you have to enter the season confused or ill-prepared. Knowing the ins and outs of tax reciprocity, along with other state and federal rules, will help make filing easier and faster.  

Want to know more about taxes? Visit the PrimePay Wage and Tax Portal, our one-stop-shop for minimum wage updates, tax rates, and benefit contribution limits.