Multi State Payroll: What Employers Need to Know About Tax Compliance

Hiring employees across state lines can create payroll obligations long before anyone thinks of the company as a multistate employer.

An employee working remotely from another state may require different state and local income tax withholding, unemployment insurance tax treatment, payroll registrations, state-mandated deductions and new-hire reporting. And if an existing employee moves to another state, those requirements can change even though the employee's job does not.

For employers, accurate multi-state payroll starts with knowing where employees live, where they actually work and which rules apply to each payroll obligation.

Why Employee Work Location Matters for Multi-State Payroll

A common starting point for multi-state payroll is the idea of "boots on the ground": Where is the employee physically performing services?

For many state and local payroll requirements, an employee's work location matters. However, employers should not assume one location automatically determines every tax and reporting obligation.

State income tax withholding may depend on both the employee's work state and state of residence. Unemployment insurance uses its own rules for determining which state receives unemployment taxes. Cities and other local jurisdictions may impose additional payroll taxes, while certain state programs require separate employee deductions or employer contributions.

As a result, adding an employee in a new state can require more than simply adding a different home address to the payroll system.

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Determine State Income Tax Withholding for Remote Employees

When an employee lives and works in the same state, state income tax withholding is often relatively straightforward. Multistate arrangements can become more complicated.

Work State vs. State of Residence

For an employee who lives in one state and works in another, employers need to determine which state's income tax withholding requirements apply. The answer depends on the laws of the states involved.

Reciprocal State Tax Agreements

Some states have reciprocal agreements that allow qualifying employees who live in one state and work in another to have income tax withheld only for their state of residence.

Convenience-of-the-Employer Rules

Other situations are more complex. Certain states use "convenience of the employer" rules that may treat wages earned while working remotely outside the employer's state as taxable in the employer's state under certain circumstances. New York is one prominent example.

Employees also may have tax obligations in both their work and resident states, although resident-state tax credits may help prevent the same income from effectively being taxed twice. From the employer's perspective, the critical issue is determining the appropriate withholding treatment rather than assuming taxes should always be withheld where the employee lives.

Because state rules differ, payroll withholding should be evaluated whenever an employee begins working in a new state.

Don't Overlook Local Payroll Taxes

State withholding is not always the end of the analysis.

Some cities and other local jurisdictions impose income, occupational or other payroll-related taxes. Depending on the jurisdiction, the tax may apply based on where an employee lives, where the employee works or both.

That means two employees working in the same state could still require different payroll withholding because they live or work in different local tax jurisdictions.

Employers expanding their remote workforce should therefore evaluate both state and applicable local payroll taxes when setting up an employee's work location.

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Determine the Correct State for Unemployment Insurance Taxes

State unemployment insurance (UI) taxes require a separate analysis.

Employers should not assume UI taxes automatically belong to the employee's state of residence or the state where the company's headquarters are located. The goal of the multistate UI rules is generally to assign an employee's services to a single state.

Start With Where the Employee’s Work Is Localized

The analysis begins by determining whether the employee's work is localized in one state. Work generally may be considered localized when the employee performs all services in one state or performs services primarily in one state with only incidental work elsewhere.

What If an Employee Works in Multiple States?

If the employee's work is not localized in one state, additional tests generally consider:

Base of operations

The location from which the employee regularly starts work or conducts work-related activities.

Place of direction or control

The location from which the employer directs or controls the employee's work.

Employee residence

The employee's state of residence may become relevant when the previous tests do not establish the appropriate state.

These rules are particularly important for employees who regularly perform services in multiple states rather than working permanently from one remote location.

When Reciprocal UI Coverage May Apply

Interstate reciprocal coverage arrangements also may be available in certain circumstances, but they should not be viewed as a general way for employers to report unemployment taxes for all remote employees through the company's headquarters state.

Employers should determine the correct UI state and establish any required unemployment tax account before wages are reported.

Register for Required State and Local Payroll Accounts

Hiring an employee in a new state may require the employer to establish new payroll tax accounts before processing payroll.

Depending on the jurisdiction and the employee's circumstances, registrations may include:

• State income tax withholding
• State unemployment insurance
• Applicable local payroll or income taxes
• State paid family and medical leave programs
• State disability or other payroll-funded programs

Each program can have its own registration process, tax rate, wage base, filing schedule and payment requirements.

Payroll registration also is only one piece of hiring across state lines. Having an employee in another state may create broader business registration, workers' compensation and employment-law requirements.

Employers should identify both payroll and broader compliance requirements before an employee begins regularly working in a new state.

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Account for State-Mandated Payroll Contributions and Deductions

Multistate payroll also may involve state programs that are funded through employee payroll deductions, employer contributions or a combination of the two.

Paid family and medical leave programs are one increasingly common example. Several states and the District of Columbia operate mandatory paid family and medical leave programs, and requirements differ considerably by jurisdiction.

Some states also maintain disability insurance or other employee benefit programs funded through payroll.

From a payroll perspective, employers may need to determine:

• Whether the employee is covered by the program
• Which wages are subject to contributions
• Whether contributions are paid by the employee, employer or both
• The correct contribution rate
• Applicable wage limits
• How deductions and employer contributions are reported and remitted

Rates, wage limits and program requirements can change, making ongoing payroll compliance important even after the initial setup is complete.

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Understand Multistate New-Hire Reporting Requirements

Employers generally must report newly hired and rehired employees within 20 days of the employee's hire date.

A company with employees in multiple states generally can handle new-hire reporting in one of two ways.

Reporting New Hires State by State

The employer may report each employee to the state where that employee works, following the applicable state's reporting requirements.

The Single-State Reporting Option for Multistate Employers

Alternatively, an eligible multistate employer may register as a multistate employer and designate one state in which it has employees as the state where it will report its newly hired and rehired employees. The employer must register its reporting choice and follow the federal multistate reporting requirements.

The federal Child Support Portal now provides the process for registering a company as a multistate employer and identifying the state where the company will submit its new-hire reports.

Importantly, selecting one state for multistate new-hire reporting does not mean that state also becomes the proper state for income tax withholding, unemployment insurance or other payroll taxes. Those obligations must be determined separately.

Reevaluate Payroll When an Employee Moves to Another State

Multistate payroll issues do not arise only when a company hires someone new.

An existing remote employee may move across state lines, begin working regularly from a second home or relocate without recognizing that the change affects payroll.

Once an employee begins working from a new state, the employer may need to reevaluate:

• State income tax withholding
• Local payroll taxes
• Unemployment insurance
• State payroll account registrations
• Paid leave or disability program contributions
• Other state-specific payroll deductions or taxes

The required changes may need to take effect based on when the employee begins working in the new jurisdiction, not when payroll eventually learns about the move.

For that reason, employers should require remote and hybrid employees to provide advance notice before changing their regular work location. Payroll can then review the new jurisdiction and make necessary changes before wages are processed incorrectly.

Simplify Multistate Payroll Compliance

Employing people across state lines can expand a company's access to talent, but every new work location can add another layer to payroll compliance.

State and local withholding, unemployment insurance, payroll registrations, required deductions and new-hire reporting can all vary based on where employees live and work. A process that works correctly for one employee may not work for another employee performing the same job from a different state.

Axcet HR Solutions helps small and mid-sized businesses manage multistate payroll as part of our comprehensive PEO payroll services. Our payroll professionals support accurate payroll administration, tax withholding and reporting while helping employers manage the complexity that comes with a workforce spread across multiple states.

Reach out to find out how Axcet can help simplify payroll and HR administration as your business grows >>