On Friday, September 2, New Jersey Governor Chris Christie announced that a $250 million budget gap has forced him to withdraw from a decades-old agreement that allows New Jersey and Pennsylvania residents who work across state lines to pay income taxes where they live instead of where they work. Under the Reciprocal Personal Income Tax Agreement of 1977, a resident of New Jersey who works in Pennsylvania need only file a tax return in New Jersey. The same is true for a Pennsylvania resident working in New Jersey. The agreement covers salaries, wages, tips, commissions and bonuses received by an employee for services rendered.
The reciprocal agreement is advantageous for high-income Pennsylvania residents who work in New Jersey, because they pay their state’s lower tax rate. It is also good for middle-income New Jersey residents who work across the border because of New Jersey’s progressive tax system. The Census Bureau estimates 125,000 Pennsylvania residents commute to New Jersey for work and another 125,000 New Jersey residents work in Pennsylvania. Scrapping the deal means residents of one state who work in the other would have to file two tax returns and claim a credit against taxes owed where they live for taxes paid to the state where they work.
The tax change is expected to reap $180 million for New Jersey and $35 million for Pennsylvania, but it comes at a cost to some residents of both states who will get socked with higher income taxes. Pennsylvania has a flat 3.07% tax rate regardless of income, whereas New Jersey has six marginal income tax rates, ranging from 1.4% for those earning $20,000 or less to 8.97% for income greater than $500,000. Currently, a highly paid executive living in Pennsylvania but working in New Jersey can pay Pennsylvania’s 3.07% tax. An end to the reciprocal agreement means he will have to pay the higher New Jersey tax rates. Likewise, a low-income New Jersey resident working in Pennsylvania currently pays the lower New Jersey tax of 1.75%. Without the agreement, the taxpayer will have to pay the higher 3.07% tax to Pennsylvania and will only be entitled to a New Jersey tax credit equal to the 1.75% resident tax rate, resulting in an additional 1.32% of net tax being paid.
Either state can withdraw from the Reciprocal Personal Income Tax Agreement by simply providing 120 days’ written notice. The deadline for notice this year was Friday, September 2. Governor Christie did, however, leave open the possibility that he would reconsider ending the New Jersey-Pennsylvania tax agreement if state legislators can come up with another solution to bridge the state’s budget shortfall. If no alternative is reached, the tax changes will become effective as of January 1, 2017.