In 2020, the COVID-19 pandemic threw universities and colleges into the remote workers' quagmire. In the years following, however, many in higher education discovered that offering remote work gives them a competitive edge in retaining valued staff members. So, the practice of hiring remote workers and offering remote work to current employees is on the rise.
Inherent in the growth of remote staff members, though, is the increase in payroll processing duties and related complications. When employees not only work remotely but live and work in different states, multi-state payroll tax withholding becomes a major hurdle.
How Does Withholding Work When a Remote Worker Lives and Works in the Same State?
As a general rule, state laws require employers to withhold income taxes from an employee's compensation based on the tax withholding rules in effect for the state in which the employee performs the work. That means residents and non-residents alike.
Of course, some states do not require payroll withholding at all and that keeps things pretty simple. Those states are:
- New Hampshire
- South Dakota
- Washington State
Payroll processing for on-site employees and for remote employees who live and work in the same state works basically the same way. One potential complication occurs when the local jurisdiction (city or county) where the remote employee lives has different income tax rates than the jurisdiction where the employee performs the work.
What Happens When Remote Staff Members Live in One State and Work in a Different State?
States have the legal right to impose state income taxes on compensation earned by their residents, whether they earn income in the home state or in another state. For example, a state's tax withholding laws may require an employer to withhold state income taxes based on an employee's state of residence even if the employee does not perform work there.
This situation happens most often when an employer has a business presence or operations in more than one state. This is known as having a "nexus" to the state. A store or other location may create such a nexus. An employee who makes sales or service calls in the state may also create a nexus. And remote employees working from their personal residences may also create enough of a tax nexus as to require the employer to withhold income taxes from the employee's compensation in accordance with the employee's home state's income tax withholding rules.
Having to withhold income tax for both the work jurisdiction and the residence jurisdiction may result in double taxation. To avoid that circumstance, states adopt various escape provisions. For example, the tax implications of working and living in different states frequently depends on cooperation agreements between the employee's state of residence and the state where the employee performs work. These agreements are reciprocity agreements. Other states may adopt non-resident taxation thresholds, or rules related to income sourcing
States with a Reciprocity Agreement
A reciprocity agreement between two states refers to the legally binding agreement that income tax withholding will only apply to an employee's compensation at the rate imposed by the state of residence. Sixteen states and the District of Columbia have reciprocity agreements with other states. For example, New York State and Connecticut have such an agreement. Maryland and the District of Columbia also have a reciprocity agreement. These agreements simplify employer compliance with state income tax withholding rules and avoid double taxation for employees.
States with Non-Resident Taxation Threshold
Alternatively, states may adopt a non-resident income threshold. In this type of arrangement, the state does not impose taxes on a non-resident employee's compensation until the non-resident employee earns a specified amount of wages within the state. Others do not impose taxes until the non-resident employee works a specified number of days in that state. After the employee meets the non-resident income threshold, the state will impose its income tax withholding requirement on the employer. The state may collect the tax from the threshold point forward, or retroactively for the entire period of work in that state.
One example of a state using the income tax threshold is Louisiana. Louisiana recently adopted a 25-day threshold for non-residents working in the state. Non-residents working less than 25 days in a month are exempt from paying Louisiana state income taxes. West Virginia has a 30-day income tax threshold for non-residents working there.
States with Income Sourcing Rules
Another mechanism states use to avoid double taxation is income sourcing rules. Some states provide a tax credit to a resident employee who pays non-resident taxes to another state. The states limit the tax credit allowance, in most cases, to the amount of resident state tax imposed on the out-of-state income. This sometimes increases the employee's income taxes in the home state if the tax credit does not cover the full amount of non-resident tax imposed.
What Happens if a Staff Member Works in Multiple, Different States?
Employees who work in more than one state face income tax withholding for each state in which they worked even if it is for just one day. States have the legal right to tax all income of their residents whether they earn that income in-state or not. The power to tax non-residents is not so broad. A state's right to tax non-residents is limited to income earned from a job in that state.
Some states adopt a "convenience of the employer" rule that may mean the employer withholds income taxes based on the employer's location rather than the state where the employee lives. This rule applies if the employer requires the employee to work in another state. In that scenario, the employer withholds taxes based on the employer's location. If the employee voluntarily works remotely from another state, then the employer withholds taxes based on the employee's location.
The Easiest Way to Avoid Multi-State Payroll Headaches
To understand and comply with the various multi-state payroll issues throughout the U.S. requires in-depth research and a thorough working knowledge of nationwide HR compliance rules and regulations. For all practical purposes, that means keeping up with new legislation and modifications to current HR rules. And that makes HR payroll compliance a full-time job. Sometimes that job is outside the expertise of an HR department. In small to mid-size firms with a limited HR staff, the job may become an oversized burden.
The cost-effective way for a business to gain control over multi-state payroll taxes is to hire a Professional Employer Organization (PEO) as the business's HR outsource partner.
The PEO has the expertise and staff to keep up with the complex rules. The PEO shifts some responsibility for compliance from your shoulders to your HR partner. That means you and your staff can concentrate on growing your business.