I live in NJ and work in NYC. I checked with my employer and I have 0 state withholding allowance for both NJ and NY. I filed my taxes for 2007 and I received a refund from NY state and I owed taxes in NJ.

How I set up my withholding allowance so I don't end up having to owe NJ?

Should I have withholding allowances in each state? If so, how much?

Which forms do I fill out to make these changes? NJ-W4, IT-2104.4, IT-2104?

Thanks!

Are you having taxes currently being withheld for NJ? If you want your employer to withhold more taxes for NJ, you can request that they withhold an additoinal amount amount per paycheck - there should be a spot on the NJ W4 for that.

Currently my state allowance for NJ is zero. NY is also zero.

I will calculate the allowance for the NJ-W4.

As for NY, do I still pay taxes in the state that work in? My current allowance is zero, yet taxes for NY have been taken deducted. Is this normal? Are you automatically taxed in the state that you work in?

Yes - you owe taxes for the state in which you work. In New York workers who live out of state have to file a non-resident income tax form, IT-203. After you figure your NY taxes, you then determine your NJ taxes - the initial calculation requires you to report all income, then you calculate the NJ income tax that would be due on that full amount, then you take a credit for taxes paid to other jurisdictions (in this case, NY). For most people with only one income it turns out that the credit for NY taxes entirely offsets the NJ income tax, so you could wind up owing NJ nothing. Exceptions are for couples with two incomes, or those who have significant income from other sources. When you said that you owe NJ money, I assume you were in one of these two groups. But now it sounds as if you haven't figured out your NY tax burden yet - is that right?