In today’s digital age, many employers are now hiring across state lines, building a robust remote workforce living and working in various parts of the country. While this allows organizations to hire from a broader pool of top talent, it can pose several compliance challenges, especially when it comes to payroll taxes. Employers must learn to navigate various state payroll tax laws and deadlines, withholding requirements, and unemployment insurance obligations, all of which can differ greatly depending on the state in which the employee resides. In this guide, we explain everything to know about payroll taxes for out-of-state employees, breaking down essential tips for handling payroll taxes to stay compliant and avoid common pitfalls.
Key Takeaways
- Multi-state payroll is becoming increasingly complex, as the rise of remote work and hybrid teams increase the need for compliance across multiple state tax systems.
- Employers must withhold payroll taxes where the employee physically performs work, not necessarily where the employer is located. Exceptions include states that do not collect income tax or have reciprocity agreements.
- Employers must also manage state unemployment insurance, workers’ compensation, and other state employment taxes.
- Working with a payroll service provider like Experian Employer Services helps streamline the payroll process to ensure compliance at every step.
The Growing Complexity of Payroll Taxes for Out-of-State Employees
With the rise of remote and hybrid work arrangements, employers are now finding themselves with staff who perform duties outside of where they are based. This makes payroll taxes for out-of-state employees increasingly complex, as each state has its own tax laws, thresholds for tax nexus, and rules about tax withholding and unemployment insurance requirements. Additionally, some states may have reciprocity agreements in place to avoid the double taxation of employees, further complicating withholding requirements. As a result, businesses must stay informed and adapt quickly in order to maintain compliance and avoid potential penalties.
Breaking Down State Income Tax Obligations for Remote Workers
Each state has its own income tax obligations that employers need to understand, as these obligations determine how much needs to be withheld and allocated toward unemployment insurance and other state programs. Knowing the key elements of multi-state payroll tax withholding compliance ensures employees have the appropriate amount of taxes withdrawn each pay period and that overpayments are not made.
Understanding State Income Tax Withholding
When an employee works in a different state from where the employer is established, the employer may be required to withhold income taxes in the state where the employee performs work, not where they’re headquartered. Most states require employers to withhold taxes from wages earned in the state, not where the employer is based. This means employers must register with the employee’s work state tax authority to ensure the appropriate amount of taxes is withheld and remitted according to that state’s tax laws. These can vary in terms of thresholds and filing frequency, and employers must be on top of these requirements in order to remain compliant.
Reciprocal Agreements Between States
A reciprocity agreement is an agreement between two or more states that allows residents of one state to work in another without having income tax withheld in the state in which they work. Instead, taxes are only paid to the employee’s state of residence, ensuring they aren’t taxed twice on their income. These agreements help to simplify payroll tax administration for employers and are common between states with high-density cities on state borders where workers regularly cross state lines, such as New York and New Jersey.
What to Do When No Reciprocal Agreement Exists
In some cases, states do not have reciprocal agreements in place, which means employers may be required to withhold income taxes for both the employee’s resident state and the state where work is performed. In cases like these, states will often offer a credit for taxes paid to another state to help prevent double taxation. Employers will need to register for a withholding account in the employee’s state of residence and work state, monitor thresholds that may trigger filing requirements, and work with the employee to ensure accurate withholding and prevent the overpayment or underpayment of taxes.
Employer Responsibilities for Multi-State Payroll Tax Withholding
Compliance is key to avoiding penalties and fines that not only impact your bottom line but can have a negative effect on your reputation and employee experience. There are several key responsibilities for managing multi-state payroll tax withholding to ensure compliance, such as:
- Determine employee work location: Accurately identify where each employee performs work to determine which state’s income tax and unemployment insurance rules apply. Even occasional or part-time work in another state can trigger state income taxes.
- Register with state tax authorities: When an employee is working in another state, employers must register with that state’s department of revenue for income tax withholding, as well as that state’s unemployment insurance agency.
- Withhold state income taxes: It’s the employer’s responsibility to accurately withhold the correct amount of state income taxes based on their work location, unless reciprocity agreements are in place, to avoid penalties and back taxes.
- File state payroll tax returns: Each year, employers must file state payroll tax returns, remit payments, and submit annual reconciliation forms to each applicable state. It’s important to note that filing frequencies and due dates can vary by state.
- Administer W-2s: At year-end, employers will need to provide accurate W-2s that reflect state wages and taxes withheld.
State and Local Employer Obligations Beyond Income Tax
Along with managing state income taxes for out-of-state employees, there are other obligations employers are responsible for to maintain compliance.
Unemployment Insurance and Workers’ Comp
In addition to income tax withholding, employers are required to contribute to state unemployment insurance (SUI) programs and carry workers’ compensation insurance in each state where they have employees.
Most states require employers to pay into their state unemployment insurance fund. The rate and wage base vary by state, and new employers may be assigned a standard rate until they establish an experience rating.
States also mandate employers to have workers’ compensation insurance to protect employees in the event of a job-related injury. Employers will need to ensure they are properly insured in each state in which they have employees working, even if they are remote.
Mergers and Acquisitions
When a company merges with or acquires another company, it can significantly impact state payroll taxes. Acquiring entities may need to re-register with state tax agencies and acquire new SUI account numbers, as well as track wage bases already met in one entity to avoid overpaying UI taxes under the new structure.
Lookbacks
A lookback period refers to the time frame employers use to determine how frequently to remit payroll taxes and their deposit schedule. For example, a state may look at the total payroll taxes paid during the previous year or quarter to determine your payment frequency, such as monthly or semiweekly. Some states may also use a lookback period to determine state unemployment insurance contributions and whether an employer qualifies for electronic filing mandates or needs to remit UI contributions more frequently.
Tools and Partners to Ensure Payroll Tax Accuracy
Managing multi-state payroll taxes can be challenging, but working with the right partner can help. At Experian Employer Services, our Payroll Tax Compliance Services streamline payroll tax processes for employers to recover overpayments, reduce internal costs, and increase compliance. Partners can leverage several necessary tools to ensure payroll tax accuracy, such as:
- Unemployment cost and claims management: Optimize and reduce SUI tax liabilities, increase compliance, and recover overpayments.
- Payroll tax merger and acquisition services: Ensure compliance and optimize savings with services like federal and state successor analysis/implementation, account compliance services, due diligence review, and payroll tax process harmonization.
- Consulting: When unexpected hurdles arise, turn to payroll tax compliance providers to navigate complex issues to resolve these roadblocks on an as-needed basis.
- Refund recovery: Identity and recover federal, state, and local overpayments to protect your bottom line.
- Account compliance: Work with experts who can help you register, update, and close state and local payroll tax accounts that are no longer needed.
- Audit support: Receive professional support throughout all phases of a payroll tax audit to identify any non-compliance risks.
How to Avoid Common Payroll Tax Mistakes
A simple mistake can result in costly penalties and fines. For employers managing out-of-state employees, keep these common pitfalls in mind so you know what to avoid:
- Misclassifying employees: Ensure all employees are properly classified, as misclassifying workers as independent contractors when they should be employees can lead to back taxes, interest, and penalties.
- Failing to withhold and remit state taxes: Make sure to withhold payroll taxes based on where an employee works, not just where your business is located.
- Misunderstanding reciprocal agreements: If you have employees in neighboring states, determine whether reciprocal agreements are in place to avoid withholding in the wrong state or double taxation.
- Failing to track employee work locations: For remote workers, maintain accurate records of where they live and where work is performed to ensure the proper state payroll taxes are collected.
How Experian Helps Employers Navigate Multi-State Payroll Tax Compliance
At Experian Employer Services, we make understanding tax withholding for remote employees easy with our Payroll Tax Compliance Services. Turn to us as your trusted partner to streamline your payroll process with our consulting services designed to address the unique and unexpected issues that arise in payroll all the time.
Frequently Asked Questions
How do I determine if I need to withhold taxes for an employee working remotely?
To determine whether you need to withhold taxes for an employee working remotely, you will first need to identify whether that state collects income tax, whether there are reciprocal agreements in place, and the employee’s residence and work location. If an employee works in another state, even for a short period of time, it may trigger a tax withholding requirement, especially if that state has a low threshold for establishing tax nexus.
What should I do if my employee moves to another state?
If an employee moves to another state, start by updating their location in your records and registering for payroll tax withholding and unemployment insurance in the new state. Then, check for reciprocity agreements and adjust your payroll system to begin withholding and remitting taxes to the correct state.
How can a payroll tax partner help with multi-state payroll taxes?
A payroll partner can help you navigate multi-state payroll taxes more seamlessly by helping to register or unregister your business in new states, calculate the correct amount of withholdings for each employee based on the state in which they work, recover overpayments, and ensure filing and payment deadlines are met, among other responsibilities. A payroll tax partner like Experian Employer Services can help boost efficiency and your bottom line.
What happens if I fail to withhold the correct taxes for out-of-state employees?
Failing to withhold the correct taxes for out-of-state employees can lead to penalties, fines, back taxes, and interest, along with a possible audit.
Can Experian Employer Services help with multi-state payroll tax compliance?
Yes, at Experian Employer Services, our Payroll Tax Compliance Services help employers navigate multi-state payroll tax compliance.