If you are new to the field, or you suddenly hear one of the terms applies to you because of a move, or decision to work from home, you may have no comprehension of what they mean. We’ve created this quick guide to help you out if you, or one of your employees, has a question about nexus or reciprocity.
What is Nexus?
Nexus is something a business can 'have'. At the most basic level, if a business has nexus in a state, it means that the business has a presence in the state, and therefore subject to state income taxes within the state. A business has nexus in a state if it owns or leases property in the state, derives income from within the state, has capital or property in the state, or employs personnel in the state in activities that exceed 'mere solicitation'. Nexus requirements vary from state to state.
For example: An employee works from their home office, and that home office is in a state that the employer has no physical presence (ie no offices). Because this employee works from their home, that automatically gives a company nexus in that state. This mandates that company to become registered in that state, and the company is also now subject to income tax in that state.
What is Reciprocity?
First, a little background knowledge: Almost every single state that impose a personal income tax require that the tax be paid on all income earned in the state, including income earned by non-residents. Non-residents generally have to pay this income tax by filing a non-resident income tax return with the state, and a regular annual tax return for all income earned (if any) in the state in which they live. These tax returns include all income earned, regardless of where it was earned. Usually, residents can take a credit on the return for their state of residence for taxes paid to other states.
As you can imagine, this is not ideal for taxpayers to have a double burden. To combat this, many states have entered into state tax reciprocal agreements. 'Reciprocity' is usually used in terms of this type of agreement, which allows residents of one state to request exemption from tax withholding in another state. A reciprocal agreement is made between two states.
For example: An employee lives in New Jersey and works in Pennsylvania. These two states have a reciprocal agreement, and so the employee, who lives in New Jersey, can ask their employer to stop withholding Pennsylvania taxes. This saves the employee time and money, and makes it so they only have to file a New Jersey return. Because the agreement is between the two states, the same would be true if the employee lived in Pennsylvania, and worked in New Jersey – the employee would only have to pay taxes in the state in which they reside.