The increase in remote work has been an amazing outcome from the pandemic for many. But with that comes an increase in challenges relating to managing employee tax withholding. With more than 17 million more people working remotely today (even if it’s not fully remote), it’s more important than ever for employers to better understand how they should treat tax withholding and Managing Out-Of-State Employee Payroll and Taxes for these remote employees who may reside in a different state.
Every state has its own rules on how telecommuters are treated based on local tax regulations. The complexity and variance from state to state means employers need to have the right combination of people, processes, and technologies to manage the challenges of payroll tax withholding for these remote employees.
Generally, taxes should be withheld for the state where services are performed. But because many employees now work in multiple states or telecommute, employers are forced to follow a patchwork of local tax regulations set by states and cities.
No matter, it is important employers understand the state income tax situation for remote workers. Then, they avoid non-compliance with state laws that can result in penalties and fines. It’s also important so employers can leverage state-specific tax incentives, credits and deductions.
Learn more about the important considerations that need to be made in these scenarios below.
The Importance of Tax Nexus
Tax nexus is important to understand when it comes to state tax withholding. Each state has a different threshold for establishing tax nexus. For example, if a company is physically located in Oregon, but sells its items in California and Colorado, there will need to be state tax withholding differences. Tax nexus is established in California if there are over $500,000 of sales made. But in Colorado, the threshold is only $100,000. This is why it’s important to understand each state’s tax nexus requirements. This ensures the correct amount of taxes are withheld, based on which state the business is operating in.
Reciprocity Agreements
Some states have tax reciprocity. That means there are agreements in place with other specific states that allow employers to withhold taxes based on the state of residence, instead of where an employee works. In these cases, an employee can give you a reciprocal withholding certificate if they want you to withhold taxes for their home state instead of the work state. This will excuse them from tax withholding in the state where your business is located. However, this is only doable if both locations have a reciprocity agreement in place. Having reciprocity agreements in place can greatly simplify remote work payroll taxes for employees, as well.
In Wisconsin, where KBS is headquartered, there are reciprocity agreements in place with Illinois, Indiana, Kentucky and Michigan.
Remote Worker Considerations
States with no income tax, like Texas and Washington, are popular for remote workers. But they may be responsible for other taxes or mandatory employee benefits. Remember, employers are responsible for withholding federal income taxes, FICA taxes (Social Security and Medicare) and federal unemployment taxes (FUTA) for remote workers. But independent contractors are self-employed and responsible for managing their own taxes. Instead, you’ll send them Form W-9 to collect their taxpaying details. Then at tax time, file a 1099 with the IRS with the total amount you paid them for the previous year. It’s up to employers to stay up-to-date on all tax laws and requirements for remote employees.
Payroll Considerations
There are several best practices to follow to ensure compliance when it comes to setting up payroll to handle multi-state employees.
- Determine employee residency
- Determine employee working location, especially for those who telecommute or work across state lines
- Register with the applicable tax and labor agencies in each state to ensure compliance with state-specific regulations
- Utilize payroll software for tax withholdings – this can ensure compliance and accurate tax withholding and tax filing
- If you employee people at minimum wage, it’s important to keep track of each state’s minimum wage rates
- Pay frequency may be different based on state requirements that determine how often you need to pay your employees and will need to be monitored
- Overtime calculations may be different in certain states and will need to be properly handled (daily versus weekly overtime requirements)
Automate The Process
Many different software services offer a solution for automating the tax withholding process for remote employees. This will provide all necessary tax forms based on an employee’s work and home address. It can help to streamline the onboarding and payroll process for remote employees, as well. By automating this key piece of information, it helps employees and employers avoid tax-time surprises and manage the ever-expanding growth of telecommuting.
The same is true for multi-state payroll taxes, which can be complex. Getting them right can require a hefty amount of time and research, which can lead to avoidable errors, costly mistakes and a great deal of wasted time. But, by using an expert service provider when your workforce is in multiple states can be well worth the investment. It takes the burden off you for staying current on laws and requirements and gives you the freedom to focus on growing your business instead.
Legal Implications of Incorrect Withholding
Careful attention needs to be paid to state tax withholding for remote employees. You will want to ensure you are accurately withholding the correct amount of taxes from each paycheck based on the employee’s withholding elections. Failure to do so can result in various legal implications, depending on the severity of the error. It can result in penalties and interest, which can hurt your bottom line and reputation. Other legal implications include liens against property and assets, criminal sanctions and in severe cases, jail sentences.
The bottom line is that payroll and taxes are areas that your business can’t afford to get wrong. It can be a complicated process, so having a good payroll system in place is essential, or a good payroll business partner to help you along the way. No matter where your employees are across the country, you’ll need to keep detailed and accurate records for your business. For more information on your state’s rules, check with your taxing authority like the Department of Revenue. The Federation of Tax Administrators has a list of each state’s tax agency’s website that you can check, as well.