Does California Have a Reciprocity Agreement With Arizona?

Understanding state tax agreements is crucial for individuals who live in one state and work in another, as these agreements can significantly impact tax obligations and filing requirements. The relationship between California and Arizona is of particular interest due to their proximity and economic ties. This discussion explores whether a reciprocity agreement exists between these states and its implications for cross-border workers.

Reciprocity Basics

State tax reciprocity agreements aim to prevent double taxation for individuals living in one state and working in another. These agreements vary by state, and there is no such agreement between California and Arizona. In the absence of reciprocity, employers in the state of employment typically withhold taxes for that state. For example, Arizona employers withhold Arizona state income taxes for California residents working in Arizona. Employees can adjust withholding to reflect taxes owed to their home state by completing a state-specific withholding exemption certificate.

Nonresident Withholding

Without a reciprocity agreement, nonresident withholding becomes a key consideration. Arizona employers withhold state income taxes for nonresidents, such as Californians working in Arizona. Employees should communicate with their employers to ensure withholding aligns with their tax obligations, which may require additional paperwork.

Wage Allocation

Wage allocation determines how income is taxed between states. California residents working in Arizona must allocate wages based on the time spent working in each state. For example, an employee working part of the year in California and part in Arizona must divide their income proportionally. This ensures taxes are paid to the appropriate state based on where the income was earned.

State Income Allocation

State income allocation involves determining which state taxes specific types of income, such as wages, rental income, or dividends. California taxes residents on income from all sources, while Arizona has its own rules. California residents must report all income, including that earned in Arizona, while Arizona residents report income earned in California. Understanding these differences is essential to filing taxes correctly and avoiding double taxation.

Current Status of CA-AZ Reciprocity

California and Arizona do not have a tax reciprocity agreement. As a result, individuals living in one state and working in the other must navigate separate tax rules. Arizona requires nonresidents earning income within its borders to file a nonresident tax return under Arizona Revised Statutes 43-1091. Similarly, California residents must report all income, including income earned in Arizona, under California Revenue and Taxation Code 17041.

The lack of reciprocity also affects how taxpayers claim credits for taxes paid to the other state. California residents paying Arizona taxes can claim a credit on their California tax return, reducing their tax liability. This is governed by California Revenue and Taxation Code 18001. Conversely, Arizona residents working in California must follow Arizona’s credit provisions under Arizona Revised Statutes 43-1071.

Cross-State Filing Requirements

For California residents working in Arizona, understanding cross-state filing requirements is critical. They must file a nonresident tax return with the Arizona Department of Revenue, detailing income earned in Arizona and calculating the corresponding tax. Arizona’s tax rates, as of 2024, range from 2.59% to 4.50%, depending on income levels. Taxpayers should use Arizona Form 140NR to report this income accurately.

Simultaneously, these individuals must file a resident tax return with the California Franchise Tax Board, reporting global income, including wages earned in Arizona. California’s progressive tax rates range from 1% to 13.3% for high-income earners. Filing California Form 540 and Schedule S is necessary to apply any tax credits for taxes paid to Arizona and avoid double taxation.

Credits for Taxes Paid to Another State

Claiming credits for taxes paid to another state is essential for avoiding double taxation. California residents earning income in Arizona can claim a credit for Arizona taxes paid, as outlined in California Revenue and Taxation Code 18001. This credit offsets California tax liability by the amount paid to Arizona.

To claim the credit, taxpayers must calculate taxes paid to Arizona and document these amounts with Arizona tax returns and payment receipts. These records are used to complete California’s Schedule S, which documents the tax credit claim. It is important to distinguish between taxes paid and taxes withheld, as only the former qualifies for the credit.

California limits the credit to the lesser of the tax paid to Arizona or the California tax on the same income. This requires careful comparison of tax liabilities between the states, often necessitating detailed calculations or tax software to ensure accuracy.