New Jersey to Terminate Reciprocal Withholding Agreement With Pennsylvania

Author: Rena Pirsos, XpertHR Legal Editor

September 7, 2016

On September 2, New Jersey Governor Chris Christie gave 120 days' required notice of intent to end the state's 40-year-old reciprocal income tax withholding agreement with Pennsylvania. If New Jersey follows through, the agreement will terminate at the end of 2016, affecting employers and employees in both states. New Jersey's impending action, however, is still in an early phase and the situation could change by the end of the year.

Employees who live in one state but work in another are subject to both states' income taxes. These employees must file income tax returns in both states, but can usually obtain a credit on their resident income tax returns for the amount of tax withheld for their work state.

Reciprocal income tax withholding agreements between states allow an employer to withhold and remit income taxes for an employee's state of residence only, and the employee only has to file one income tax return - with the state in which he or she lives.

Under the New Jersey/Pennsylvania reciprocity agreement, a New Jersey resident who works in Pennsylvania files Form REV-419 EX, Employee's Nonwithholding Application Certificate, with his or her Pennsylvania employer. This permits the Pennsylvania employer to withhold only New Jersey income taxes from the employee's pay.

The reciprocity agreement, however, does not affect Pennsylvania local income taxes. Consequently, a Pennsylvania employer must still account for local income taxes in determining the amount of New Jersey income taxes to withhold.

For example, if an employee's Philadelphia Wage Tax is greater than his or her New Jersey income tax, the Pennsylvania employer would not withhold New Jersey income tax, if the following two criteria are met:

  • The Philadelphia Wage Tax is withheld from the employee's wages; and
  • The New Jersey employee works solely within Philadelphia.

Likewise, a Pennsylvania resident who works in New Jersey must file New Jersey Form 165, Employee's Certificate of Nonresidence in New Jersey, with his or her New Jersey employer to have only Pennsylvania income taxes withheld.

Approximately 240,000 employees in both states would be affected if the agreement terminates. Pennsylvania residents would end up paying more in income taxes, due to New Jersey's graduated income tax rates. In the interim, employers in New Jersey and Pennsylvania should prepare for the agreement's termination by taking the following steps:

  • Review employee payroll information to determine which employees will be affected;
  • Communicate to those employees the potential termination of the agreement and anticipated impact on their income tax withholding;
  • Provide those employees the appropriate 2017 withholding allowance certificates (Form W-4, Employee's Withholding Allowance Certificate, or optional Form NJ-W4, Employee's Withholding Allowance Certificate) so they can adjust their withholding allowances for 2017, if they so choose; and
  • Prepare to update payroll systems to begin withholding income taxes on January 1, 2017, for the affected employees' work states.