Reciprocity means that two or more states have agreed to exempt the earned income of residents of neighboring states from income taxes. These reciprocal agreements make it possible for residents of one state to work in a neighboring state while only paying income taxes to their state of residency. These agreements are common in areas where many people work across state lines.
If you live in one state and work in another, and those states have this type of reciprocal agreement, you will only need to pay taxes in your home state.
Let’s look at an example: you work in the District of Columbia, but live in Virginia. Because these two jurisdictions have a reciprocal agreement, you would file an exemption certificate with your employer in D.C. so that you do not have D.C. taxes withheld from your paycheck. Your employer would withhold taxes for Virginia instead (you may have to pay estimated payments on your own depending on the state and your employer). At the end of the year, you would file a Virginia income tax return.
Conversely, if these two jurisdictions did not have a reciprocal agreement you would have to pay income taxes to both states.
Reciprocal Agreements Don’t Cover Everything
Keep in mind that reciprocal agreements typically only cover earned income (wages, tips, and commissions) that are earned in a reciprocal state. These agreements usually do not apply to other income such as interest income, lottery winnings, capital gains, or any other income that is not earned through employment. Unearned income such as this would typically be subject to state income taxes regardless of the reciprocal agreement.
You May Still Need to File a Return in Both States
If you had taxes withheld by your employer when they should not have been you would need to file a tax return to get that money refunded to you. So, in our example above, if your employer withheld D.C. taxes from your check for a few weeks by mistake, you would have to file a D.C. tax return to get that money back