If you’re like most companies today, odds are you have employees who work remotely or from a different state than where your business is located at least some of the time. In these situations, it can be confusing to know where to withhold and remit payroll taxes – and how to do it. To help you get multi-state payroll right, here we’ll break down everything you need to know to avoid penalties and interest.
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In this article, we’ll explain the requirements for payroll tax withholding when you have employees who work in a different state than where your business is located as well as steps you can take to make sure you comply with the rules. After reading this, you’ll know how your company can avoid potential issues and costly consequences with state payroll taxes.
With each paycheck, you need to withhold and deposit payroll taxes to cover several obligations. At the federal level, these include income taxes, the employee’s and employer’s share of Social Security and Medicare taxes, and FUTA.
But you may also be responsible for state payroll tax withholdings, including:
These withholdings will vary from state to state. To understand exactly what you need to withhold, the first step is determining the correct state for purposes of income tax and the ancillary taxes we just discussed.
Income tax is the biggest and most common multi-state payroll tax withholding so we’ll start with that and then address ancillary withholdings.
As a general rule, you’ll use the state where your employee performs work to determine your withholding obligations.
But that’s not always the case. Sometimes, it can be more challenging to figure out what state governs income tax withholdings for individual employees. There are certain situations that are more complicated, such as:
In some cases, there may be reciprocal agreements between neighboring states. This basically just means there is a document stating that one state will not require income tax withholding from the other state’s residents working there. Some examples are Arizona and California or Virginia and Washington, DC. In these cases, you would only report wages to the employee’s state of residence.
So, for instance, if a nonresident employee performs services partly in and out of New York, the number of wages allocable to New York would equal the compensation for the number of days worked in New York compared to the total number of days worked out of the state.
Once you know which state you’ll need to withhold payroll taxes for employees working out of state, that location will dictate your rate. When it comes to income tax, the rates are either based on a tax table or a flat percentage. While most states use tables to determine withholding amounts based on an employee’s annualized income and their exemptions, some places, like Pennsylvania, tax everyone at a specific percentage.
For your state’s rules, check with your taxing authority like a Department of Revenue or Division of Taxation. The Federation of Tax Administrators has a list of each state’s tax agency’s website. You’ll want to check every year since the tax tables can change, and you always want to ensure you’re working with the latest versions.
Now that we’ve covered withholding for state income tax, as we mentioned at the beginning, there may be other taxes you need to withhold based on the state.
Unemployment is generally an employer-only tax. But as we explained before, in Alaska, New Jersey, and Pennsylvania, employees will also be assessed a tax. In these states, you’ll need to withhold the state unemployment tax and remit it to the state.
To determine if you’ll need to withhold state unemployment tax in one of these states, you’ll first have to identify your jurisdiction for remitting state unemployment insurance taxes. Usually, you look to the state where the employee performs services. But there are some exceptions, especially when employees work in multiple states. To make the determination in these cases, you’ll need to consider four factors:
An employee’s state for unemployment purposes may also dictate your responsibility for withholding other taxes for paid family and medical leave programs.
For example, Massachusetts has a state-paid family and medical leave program that requires employers to withhold the employee’s contributions for workers whose unemployment state is Massachusetts.
Whether you need to withhold state disability taxes is also tied to the state where you’re responsible for remitting unemployment taxes. So, if your employee’s unemployment state is Rhode Island, you would also be responsible for withholding taxes for temporary disability insurance (TDI) from a worker’s paycheck. Each of the states with TDI programs has slightly different eligibility requirements, so make sure you familiarize yourself with the rules if you need to remit TDI.
Once you’ve identified what states you need to withhold taxes for, you’ll need to follow three steps to make sure you’re compliant with the regulations.
As you can see, multi-state payroll issues can be pretty complicated, especially when states all treat tax withholding differently. And if you make a mistake and don’t get multi-state payroll tax withholding correct, you can be on the hook for costly penalties and interest as the employer. To avoid financial consequences, our state and federal resources page can give you a solid understanding of the laws to keep you compliant in your local area.