From a payroll and withholding tax perspective, some of the compliance challenges of employees working in multiple US states have been around since business travelers first started crossing state borders.
Businesses need to be aware that very typical day-to-day activities can create payroll and withholding obligations. For instance:
The problem is that as businesses start to develop more of an interstate presence, multi-state payroll consequences are not always front of mind.
As a general principle, US states assert the right to tax employees on income earned in that state. Furthermore, businesses are required to withhold taxes and to register with the tax collectors in those states. Where there is an obligation to withhold in more than one US state, this is known as a multi-state payroll obligation.
Complications quickly arise as the threshold at which businesses must operate US state withholding varies considerably and is typically expressed in relation to days spent working in each jurisdiction by the employee. For example, California requires that all wages earned in California be subject to withholding from day one. In Illinois, it is when the employee works, or is expected to work, for 30 days in the state. And for Hawaii, it is 60 days.
It is important for businesses not to confuse when they must operate US state withholding with when your employee becomes subject to tax in that US state, as these may be different. For example, in New York, you are not required to withhold state taxes until your employee works or is expected to work, more than 14 days there. In contrast, your employee may need to file a New York State tax return to report wages from day one.
You will need to focus on the following taxes in those US states where you do have a payroll withholding obligation:
While a business may have employees who live in one state and work in another, not all such situations will require tax withholding from each of the states in question. We covered some of these elements (such as reciprocal agreements) in a previous blog post, but below is a quick recap and an expansion of some of the key considerations.
There are nine US states which do not tax employment income. In these cases, it will not be necessary to withhold payroll taxes for days worked in these US states. These US states are Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.
Certain US states have established reciprocal agreements among themselves. A reciprocal agreement is an arrangement between two or more states that allows businesses to only withhold US state taxes from your employee’s home US state even if they work in a different US state. Generally (but not always), this applies to neighboring state scenarios where employees live in one nearby state but work in another. For example, Arizona has a reciprocal agreement with California. This means that if an employee is based in California but works in Arizona, the business can opt out of having to operate Arizona tax withholding.
It is important to note that not every US state has reciprocal agreements. Furthermore, reciprocal agreements do not apply to all neighboring states. For example, Illinois has reciprocal agreements in place with neighboring states Iowa, Kentucky, Michigan and Wisconsin, but not with Indiana or Missouri.
If there is no reciprocal agreement and your employee is working in a US state that levies, then your payroll team may need to withhold taxes for the US state where your employee is based and where your employee works.
As you can see from this quick tour of different state requirements, the payroll withholding situation is complex and the need to get it right to avoid penalties and interest is pressing.
To begin with, a good starting point is being able to map out answers to all five of the following:
While some smaller businesses may be able to track this data using more manual processes, larger organizations and enterprise-level companies with lots of business travelers and distributed workers will most likely need tools and technologies to maintain an up-to-date picture of where workers are located at any given time, the duration of that work and more. Topia’s solutions for business travel and distributed work are specifically designed for this purpose so that companies can feel confident that they are navigating this complicated environment with a focus on compliance.
Nothing in this article should be considered or construed as tax advice. Topia does not dispense tax advice and always recommends that taxpayers consult their accountants, tax advisers or lawyers.