With the ever-evolving workplace and the increase in the capabilities of technology, it is becoming more common for employees to work full-time remotely and reside outside of the state in which their employer is located. Therefore, it is important for employers to understand and follow state and local laws in the states where their employees work.
An out-of-state employee is considered an employee of the state in which they work, not the state in which the business is based or even the state where the employee lives.
Tax withholding requirements do vary depending on the type of remote worker. Remote workers will generally fall into one of two categories: (1) employees or (2) independent contractors.
Employers are responsible for withholding income taxes from an employee’s paycheck and paying a portion of their payroll taxes. In contrast, employers do not withhold income taxes from an independent contractor’s earnings. Independent contractors are responsible for handling their own taxes.
Employers are responsible for withholding state income tax from an employee’s wages if that employee is subject to state income tax. Each state has different rules for withholding taxes for out-of-state employees. It is important to note that the following states do not have a state income tax: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.
Employers often withhold partial amounts for the employee’s state of residence, in addition to the state the employee works in. In some cases, the employee may handle that themselves when they file their personal income tax returns.
However, remember that if an employee lives in a state that does not have a state income tax, but commutes to and works in a state that does have a state income tax (i.e., lives in South Dakota but commutes to an office or coworking space in North Dakota) then you, as their employer, must withhold income tax for the state in which they work.
In contrast to the previous statement, many states have what are called reciprocal agreements. A reciprocal agreement is an agreement between two states that allows residents of one state to request exemption from tax withholding in the other state. Using our previous example, if South Dakota and North Dakota had a reciprocal agreement, then the employer of the employee living in South Dakota, but working in North Dakota, would not be required to withhold North Dakota state income tax from the South Dakota resident employee’s paycheck.
In states where a reciprocal agreement is in effect, the employee is required to submit a reciprocal withholding certificate requesting their employer withhold from their resident state.
Additionally, some local municipalities also impose income taxes. Thus, if an employer has employees who are living and working in multiple locations the employer must also stay abreast with any potential local income taxes that need to be withheld for those employees.
State Unemployment Taxes
Just as with income tax, each state has its own rules and regulations regarding state unemployment tax.
State unemployment tax is typically paid to the state where the employee works. If an employer has employees working in multiple states, then they will need to pay unemployment taxes to each state where they have an employee working. Each state sets its own rates, wage base, and requires employers to register for an account with its state unemployment agency.
As the threat of the spread of COVID-19 continues to change and employees begin to return to in-office work many employers have begun to offer a hybrid work schedule. This may include a scenario where the employee will work a certain number of days in the office and a certain number of days at home. What does this mean for employers who have employees that work and live in different states?
Most states have an established threshold of the number of days an employee must work in that state before their employer must recognize the change of location and begin withholding income tax for that state. This threshold varies from state to state— for example, in New York, the threshold is fourteen days, but in Illinois, it is thirty days. Still, other states may have an income threshold or a combination of time and income threshold.
Additionally, some states consider whether the employee is working from home for their own convenience or as a necessity for their job. If an employee is working from home for convenience, then the employer should withhold income taxes for the state where the business is located. However, if the employee is working from home as a necessity for the work they do, then income tax should be withheld for their home state. These rules vary greatly from state to state.
In addition to simply withholding the applicable taxes, there are several additional considerations that employers who employ out-of-state employees must account for. For example, if an out-of-state employee makes minimum wage the employer needs to stay informed of the minimum wage requirements of the state in which the employee works, which may differ from the state where the employer is located.
Some states even have requirements on how frequently an employee must receive paychecks. Further, while many states apply the federal overtime regulations, some states have their own rules and regulations regarding overtime. These are just a few of the considerations beyond taxes that employers with out-of-state employees should account for.
It is important for employers to understand and comply with regional requirements around managing payroll taxes for employees working out of state. Consider employing the help of a professional tax or payroll specialist to help ensure all rules and regulations are complied with.
Remote Quality Bookkeeping offers a variety of resources to help businesses of all kinds stay up to date with their payroll and tax requirements.