Pennsylvania and New Jersey commuters who live in one state and work in the other could face materially increased state tax withholding if a nearly 40-year-old tax reciprocity compact is terminated in January under an executive order from New Jersey Governor Chris Christie.

The current reciprocity compact eliminates the need for interstate commuters to file multiple tax returns and allows them to pay tax to their resident states only. Termination of the compact could cause a Philadelphia resident working in New Jersey with an annual salary of $150,000 to face an additional tax burden of nearly $3,000.

Governor Christie left open the possibility that he might change his mind about ending the compact if the New Jersey legislature finds other ways of reducing New Jersey's budget shortfall. However, if the compact is terminated:

Employees who do not work in their resident state would be required to file returns in both states and would claim credits for taxes paid to the jurisdictions in which they work against their resident state income tax liability. Those credits would be limited to the amount of the employee's resident state tax liability; therefore, if a Pennsylvania resident who works in New Jersey owes and has withheld $1,200 of New Jersey income tax, but has Pennsylvania tax liability of $1,000, such employee would be able to offset his/her Pennsylvania liability by $1,000 of the New Jersey tax he/she paid and could apply the rest against his/her local taxes, if any (except, possibly, against Philadelphia wage tax). He/she would be unable to claim a refund of any New Jersey tax he/she paid that he/she cannot use against Pennsylvania state or local taxes.

Because Pennsylvania has a flat 3.07 percent personal income tax rate and New Jersey has a graduated tax rate (ranging from 1.4 percent to 8.97 percent), employees will be affected differently depending on how much they earn. Generally, lower-earning New Jersey residents who work in Pennsylvania and higher-earning Pennsylvania residents who work in New Jersey will pay more in taxes, while higher-earning New Jersey residents who work in Pennsylvania and lower-earning Pennsylvania residents who work in New Jersey will not see a change to their total tax liability. The executive order will affect thousands of Pennsylvania and New Jersey residents.

Although the City of Philadelphia always has required City Wage Tax to be withheld from New Jersey residents who work in the City and from City residents who work outside of the City, Philadelphia residents and employees face additional complications if the compact is revoked and may see their tax liabilities increase. The City believes that Philadelphia residents who work outside of the City can claim a credit for taxes paid to other municipalities, but cannot claim a credit for taxes paid to other states. New Jersey does not have local earned income taxes and allows its residents to claim a credit for taxes paid to Pennsylvania municipalities like Philadelphia.

Employers in Pennsylvania and New Jersey who employ interstate commuters should begin preparing for 2017 and, if applicable, begin working with payroll providers to make sure that they can comply with the new withholding requirements if the reciprocity compact is terminated as currently planned.

For several examples of how termination of the compact could affect the tax liabilities of various employees (all assuming the affected employees are single and have no deductions), click here.