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Since the start of the pandemic, remote work has become more popular across many sectors of business. At first, working from home seemed like a temporary option to ensure social distancing. However, the benefits of this model seem to outweigh its disadvantages, leading more employers to expand their hiring horizons and bring in quality talent from all corners of the globe.
This new way of working has led to many companies hiring out-of-state employees—sometimes even for the first time. With this new hiring process comes new payroll questions; namely regarding tax withholding. Managing the tax withholdings on an employee-by-employee basis can get a bit challenging, especially for small businesses that handle payroll in-house.
When setting up tax withholding and payroll for a new employee, it falls squarely under the employer’s responsibility to confirm employee residence and relevant state laws and income tax regulations for that location.
Different states have different tax regulations. The more out-of-state employees a company has, the more complicated the process can be for your Human Resources and Payroll teams. They'll have to streamline and ensure each employee receives proper payroll tax rates.
Doing proper research and understanding the specifics of each employee’s state income tax requirements will keep your payroll moving smoothly and can prevent big trouble with audits or lump-sum payments due at the end of the year.
Because each U.S. State has the autonomy to create its own laws, income regulations and tax laws vary widely by state. Where some states have a flat income tax statewide, other states vary county by county, while yet others may have no income tax at all. This is why it’s so important for businesses to understand the income tax norms of each state in detail when hiring out-of-state employees.
In addition, businesses must register in each state where an employee resides by contacting local tax agencies to initiate local registration procedures. It is necessary to follow specific guidelines for registration in every state and get an identification number. This will allow residents of those states to pay income taxes as required by their local law.
In addition to state-level income taxes, some areas also require local income taxes to be withheld from employee pay. Local income taxes are supplementary to the income tax laws of the state at large.
Local income tax is currently only present in the following 16 states: Alabama, Arkansas, Colorado, Delaware, Indiana, Iowa, Kentucky, Maryland, Michigan, Missouri, New Jersey, New York, Ohio, Oregon, Pennsylvania, and West Virginia.
Income taxes that are enforced at a local level may occur as a withholding tax (withheld from employee pay), or employer tax (paid by the business).
Almost every U.S. state taxes employee earnings in the form of state income taxes. New York, Virginia, Connecticut, and Illinois are all examples of states that require state income taxes to fund public projects and maintain state and community resources.
However, eight U.S. states do not require state income tax withholding: Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. Similarly, New Hampshire doesn’t tax earned wages. States that don’t collect taxes on income or other earned wages require no additional effort on the employer’s part when it comes to payroll; you will simply leave blank any tax withholdings in your payroll software for those areas.
While being a resident of a state that doesn’t withhold income taxes may sound appealing, employees should do their research, as many of these states have higher costs of living in other ways.
Along with the general tax laws, many states also require state unemployment taxes to be paid by employers. Those businesses with employees working in multiple states are likely to be subject to state unemployment taxes for each of those states.
By registering as a business or corporation in each state, businesses will find all information on state unemployment taxes owed based on employee hiring. Unemployment taxes vary yearly, and businesses in certain states (such as Alaska, Pennsylvania, and New Jersey) are exempt from state unemployment taxation due to other tax laws in those areas. As with all other subjects, employers are best directed to the local tax authorities in each state for a full and clear understanding of legal requirements.
Businesses can face many tax liabilities, some of which rely on the types of workers they employ in the organization.
Businesses must ensure satisfactory tax withholdings for any eligible local, state, and federal tax laws required, on a case-by-case basis, for each employee on the payroll—regardless of full-time or part-time status. To fulfill the state and federal income tax requirements, employers should withhold payroll taxes for out-of-state employees from the employees' paycheck. Proper tax withholding for remote employees is key to smooth audits during compliance season.
Because independent contractors are not recognized as employees, the companies that hire them are not obligated to assist with income tax withholdings or pay unemployment taxes on the contractor’s behalf.
Instead, the independent contractors will be responsible for declaring all earnings on their own, and paying taxes as required by law in their state of residence. This is one of the many reasons that smaller companies often opt for bringing independent contractors to their teams.
A reciprocal agreement is a formal arrangement between two states that prevents out-of-state employees from paying income taxes in their employer’s state and then paying income taxes again in the state where they reside. In essence, reciprocal agreements prevent employees from paying income taxes twice on the same work done.
However, not all states hold reciprocal agreements, and of those that do, not all agreements are exactly the same. Businesses with employees who reside and work in a different state should check to see if any reciprocal agreement exists. If yes, payroll providers will usually automatically withhold only one set of income taxes for that employee. Payroll teams may also request a certificate of exemption for qualifying employees. This certificate can be granted by the business’ local tax office.
Even without reciprocity agreements, federal law does not allow two states to tax the same income. That said, filing two returns might still be required.
Once an out-of-state employee accepts a position, there are many necessary steps to be taken:
Review tax regulations: Employers should look through the local and state tax laws to determine income tax regulations for the employee’s home state. This will help you plan to abide by those regulations in your payroll processes.
Look for reciprocal agreements: While going through the state laws of the employee’s home state, also check to see if a reciprocal agreement exists between the business’s state of operation and the employee’s state of residence.
Register as a business: The employer should register as a business in the out-of-state employee’s area as soon as possible to ensure all processes and tax laws are being followed.
Set up payroll for the new employee with withholdings scheduled to meet all requirements identified. When in doubt, consult the employee’s local tax authority, or utilize a software or subject matter expert to assist in this task.
Let’s consider an example where “Jack” is a remote worker for a company in Texas, and he lives in Washington State. The two states have different local tax withholdings, with no reciprocal agreement. Jack, thus, has to comply with both tax laws accordingly. Jack's company would withhold state income tax for that state in which he works. Jack could provide you with a state tax exemption form, at which time, you’d withhold taxes according to his home state.
Employers must be well aware of the state laws and the tax obligations of all the states where they have employed remote workers. The tax laws in each state vary, and it is essential to follow those obligations while also paying their own unemployment tax obligations.
Paying employees who live and work in different states can feel stressful, but it doesn’t have to be. Payroll software and outsourced payroll services can help businesses of all sizes manage withholdings and income tax.
Hubstaff’s payment feature, combined with a payroll provider such as Gusto, can help you better manage and pay your teams—no matter where they are in the world.
Important Notice: The information in this article is general in nature and you should consider whether the information is appropriate to your needs. Legal and other matters referred to in this article are of a general nature only and are based on Hubstaff’s interpretation of laws existing at the time and should not be relied on in place of professional advice. Hubstaff is not responsible for the content of any site owned by a third party that may be linked to this article and no warranty is made by us concerning the suitability, accuracy or timeliness of the content of any site that may be linked to this article. Hubstaff disclaims all liability (except for any liability which by law cannot be excluded) for any error, inaccuracy, or omission from the information contained in this article and any loss or damage suffered by any person directly or indirectly through relying on this information.
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