What actually happens
An employee who lives in Indiana and performs work in Kentucky sits in two tax systems at once. The residence state claims the right to tax all of a resident's income wherever earned; the work state claims the right to tax income sourced within its borders. Kentucky and Indiana resolved that overlap by agreement: the work state gives up its claim on commuters' wages entirely.
The certificate is not optional
Reciprocity does not apply automatically because the employee's address is in Indiana. It applies when the employee gives you a signed 42A809 (Certificate of Nonresidence). Until that form is in your hands you are required to withhold Kentucky tax, and an auditor will ask to see it. The form stays in your records; it is not filed with the state.
Unemployment insurance goes to one state only
Income tax can be split between states. Unemployment insurance cannot. Under the localization test used by every state, an employee whose services are performed entirely in Kentucky is covered by Kentucky for unemployment purposes, and all wages are reported there — regardless of where they live, where you are headquartered, or which state's income tax you withhold. Kentucky's 2026 taxable wage base is $12,000. The four-factor test in order.
Local taxes are a separate problem
Kentucky: Kentucky cities, counties and school districts levy occupational license (payroll) taxes ranging roughly 0.008%-2.5% (e.g., Louisville Metro, Lexington-Fayette). These are administered locally and are NOT covered by Kentucky's state reciprocity agreements -- reciprocal-state residents still owe local occupational tax on Kentucky work.
Indiana: EVERY Indiana county imposes a Local Income Tax (LIT), withheld by the employer. CRITICAL: Indiana's reciprocity agreements do NOT cover county LIT -- employers must still withhold county tax from residents of reciprocal states who have a principal place of employment in an Indiana county as of January 1. Employees expecting 30 or fewer Indiana workdays may file Form WH-4AFF to claim a county tax exemption.
What you have to register for
| Obligation | State | Agency |
|---|---|---|
| Income tax withholding | Indiana | Indiana Department of Revenue |
| Unemployment insurance | Kentucky | Kentucky Office of Unemployment Insurance (Education and Labor Cabinet) |
Frequently asked
Do Kentucky and Indiana have a reciprocal tax agreement?
Yes. Kentucky exempts Indiana residents from Kentucky income tax withholding on wages, provided the employee files 42A809 with their employer. Without that form on file the employer must still withhold Kentucky tax.
Which state's income tax should be withheld?
Indiana. Under the agreement the wages are taxable only by the state of residence, so you withhold Indiana tax and stop withholding Kentucky tax once the certificate is filed.
Which state gets the unemployment insurance wages?
Kentucky. Unemployment coverage is never split between states for a single job. The localization test assigns the whole job to the state where services are performed, which here is Kentucky, regardless of residence or where the employer is headquartered.