Many U.S. businesses employ out-of-state workers. This affects the way they do payroll and requires them to process multi-state payroll taxes to remain compliant.
How to do payroll taxes for employees working out-of-state:
Generally, if you hire an employee who lives in another state and performs work there, you will need to register to withhold income taxes in that particular state.
For example, if your business is based in New York and your employee lives and works remotely from Michigan, you would need to withhold income tax and pay state unemployment tax (SUTA) in Michigan.
There are many variations of this rule that you need to consider, depending on your business location, your employee’s place of work, their residence, terms of placement, and whether there is a reciprocal agreement between states.
Who qualifies as an out-of-state employee?
- Employees who reside and work in a different state from the one where your business is located.
- Employees that are sent to work temporarily in another state (temporary work ranges from one day to several months, depending on the state.)
- Employees that live in one state but commute to your office in a neighboring state.
What is a Reciprocal Agreement?
A reciprocal agreement, also known as reciprocity, is when one state agrees not to impose income tax on employees that work in that state but reside in another state, and vice versa. This means that you only need to withhold income taxes for the state where your employee lives.
For example, if your employee works in Illinois and lives in Iowa (two states with reciprocal agreements), they can request that you not withhold income tax in Illinois. In this case, you would only need to withhold tax in Iowa.
If your employee's work and resident states have a reciprocal agreement in place, they can claim exempt status on their withholding allowance certificate (Form W-4) to request that you only withhold taxes in their home state. This is done to save you and your employees from filing multiple tax returns. Employees also need to provide you with a Certificate of Non-residency.
For states with no reciprocal agreements, you might have to file tax returns for both the resident state and the state of employment. Check with your local government to find out more about reciprocity in your state.
States with Reciprocal Agreements:
Employee Resident State
California, Indiana, Oregon, Virginia
Texarkana, Texas and Texarkana, Arkansas
District of Columbia
Any other state
Iowa, Kentucky, Michigan, Wisconsin
Kentucky, Michigan, Ohio, Pennsylvania, Wisconsin
Illinois, Indiana, Michigan, Ohio, Virginia, West Virginia, Wisconsin
District of Columbia., Pennsylvania, Virginia, West Virginia
Illinois, Indiana, Kentucky, Minnesota, Ohio, Wisconsin
Michigan, North Dakota
Indiana, Kentucky, Michigan, Pennsylvania, West Virginia
Indiana, Maryland, New Jersey, Ohio, Virginia, West Virginia
District of Columbia, Kentucky, Maryland, Pennsylvania, West Virginia
Kentucky, Maryland, Ohio, Pennsylvania, Virginia
Illinois, Indiana, Kentucky, Michigan
Multi-State Payroll Guide:
If you are planning to undertake multi-state payroll taxes on your own, there are many things that you will need to consider. Tax rates vary from state to state, and each state has its own rules and regulations. Bear in mind that these rates and rules often change from year-to-year.
In addition, many cities and counties require additional income taxes to be withheld and remitted, which adds another layer to the payroll process. Each locality has its own rules with regards to withholding, deposits, and filing that need to be handled accurately and on time.
This is why it is important to put the correct in-house systems in place to avoid making costly errors and wasting time.
Many businesses choose to outsource their payroll administration when they are faced with multi-state employee taxes. However, if you are adamant on going it alone, you might consider speaking with a tax accountant.
You can also work with a Professional Employer Organization (PEO) to ensure that you remain compliant.
Steps for Processing Payroll Taxes for Out-of-State Employees:
Use the information on your employee's W-4 form and IRS Circular E tax-withholding tables to calculate the amount to be withheld from their paycheck.
Register with the Department of Labor in each state where you have employees to obtain your state tax ID number so that you can remit taxes.
Register your business with the Secretary of State where your employee works.
Hire a registered agent in that state to accept correspondence on your behalf.
Find out if there are any reciprocity rules and file the appropriate forms.
Find out the rules in each state for making deposits, i.e., due dates, electronic system through which payment is made, filing of forms, etc.
Register with the state unemployment agency in each state and pay your SUTA taxes.
Which states do not withhold income tax?
- New Hampshire.
- South Dakota.
How do I set up reciprocal tax withholding for my out-of-state employees?
Aside from Form W-4, your employee/s will need to fill out a non-residency certificate to exempt them from tax withholding in the state where they work.
After they’ve completed the certificate, inform your payroll provider so that they can withhold the correct amount in your employee's resident state.
Most payroll solutions can simplify this task for you by handling multi-state payroll taxes.
What is courtesy withholding?
Courtesy withholding is a benefit that employers offer to out-of-state employees. If your employee/s live in one state and work in another, you can opt to pay state income taxes or local income taxes on their behalf. However, this is not an obligation for employers.
How do I hire an out-of-state employee?
- Post your job on job boards.
- Interview and hire the candidate.
- Research the state and local tax laws where your employee resides.
- Find out each state's filing deadlines and tax rates.
- Hire a company to help you manage your payroll administration (Optional).
- Follow the steps for processing payroll taxes for out-of-state employees, above.