Non-reciprocal states are those that do not extend the same privileges or recognize certain aspects of each other’s laws, particularly concerning taxation. This absence of reciprocity means states treat residents and income from other states independently, influencing tax obligations for individuals and businesses operating across state lines.
Understanding Reciprocity and Non-Reciprocity
Reciprocity in the context of US states signifies an agreement where states mutually recognize and honor each other’s laws or tax policies. For example, a common reciprocity agreement allows a resident of one state who works in a reciprocal state to pay income tax only to their home state, avoiding a non-resident tax return in the work state. This simplifies tax obligations for individuals who commute across state lines for employment.
A bilateral agreement is a mutual pact where both states agree on how to handle income taxes for cross-border workers, allowing residents from one state working in the other to pay income taxes only to their home state. Most reciprocal tax agreements in the United States are bilateral. In contrast, non-reciprocity indicates the absence of such an agreement, requiring individuals to manage tax obligations with both states separately.
Some states, like Indiana, Minnesota, and Wisconsin, offer unilateral agreements. Here, a single state decides how it treats income earned by its residents in other states, without requiring a mutual agreement. The primary purpose of these agreements, whether bilateral or unilateral, is to streamline tax processes and prevent individuals from being taxed twice on the same income.
Income Tax Implications
When states lack an income tax reciprocity agreement, individuals living in one state and working in another generally must file income tax returns in both states. This involves filing a resident tax return for their home state, reporting all income, and a non-resident tax return for the work state, reporting income earned there.
To prevent double taxation on the same income, federal law ensures states cannot tax the same income twice. If there’s no reciprocity agreement, the individual’s home state typically offers a tax credit for taxes paid to the work state. This “credit for taxes paid to another state” helps offset the tax liability in the resident state.
The credit usually offsets the amount actually paid to the other state or the amount that would have been paid on that same income if taxed by the domiciliary state, whichever is less. For example, if a resident of a state with a 3% income tax works in a non-reciprocal state with a 5% income tax, the credit from their home state might cover the 3% tax, but the remaining 2% would still be owed to the work state.
For remote workers, “convenience rules” in some states, such as Arkansas, Delaware, Nebraska, New York, and Pennsylvania, can complicate matters. These rules may require non-resident income tax filing even if an employee works remotely from outside the state, if their employer is located in that state and the work is considered for the employer’s convenience. This means an individual could be subject to taxation by both their home state and the convenience rule state, depending on how each state defines and applies its rules.
Sales Tax Implications
Non-reciprocal sales tax policies affect consumers, particularly when purchasing goods across state lines or online. Most states with sales tax also levy a “use tax,” a complementary tax applied when sales tax was not collected at the point of sale. This allows states to collect revenue on purchases from out-of-state sellers, preventing consumers from avoiding taxation by buying items from states with lower or no sales tax.
The use tax is generally assessed at the same rate as the sales tax that would have been owed if the purchase occurred within the state’s taxing jurisdiction. For instance, if a resident of a state with sales tax purchases an item online from a seller in another state that does not charge sales tax, the consumer is responsible for reporting and paying the use tax to their home state.
For larger purchases, such as vehicles bought out-of-state, sales tax implications are typically tied to the buyer’s state of residence. Buyers generally pay sales tax in their home state where the vehicle will be registered, regardless of where the purchase took place. If sales tax was paid in the state of purchase, the buyer’s home state often provides a credit for that amount to avoid double taxation. However, if the sales tax rate in the state of purchase was lower than the home state’s rate, the buyer might owe the difference upon registration.