Working across state lines in the US imposes tax responsibilities on US employers and employees. Are your employees working remotely from another state or temporarily working remotely in another state? As an employer, you might be curious about the tax implications and labor laws for remote employees for multistate remote work within the US. In addition to the costs of hiring an employee in the US, you may face penalties if you don’t meet compliance standards.
Several countries have tax treaties (i.e., the US-Canada tax treaty), and within the US, there are similar structures as more and more Americans work remotely. For example, if there are state agreements in place, an employee may be able to avoid double taxation if they live in one state but work remotely in another. It’s important to note that they still have to file their employment income taxes to both states even if they only owe taxes to one.
With more than 35% of Americans working remotely full-time, employers must know the tax implications of multistate remote work. Some challenges employers face include nexus, sales tax, income tax, taxable employee benefits, and figuring out where their employees are!
Taxation is never straightforward. Employers must make sense of the patchwork of individual state tax codes without the right resources. Let’s take out the guesswork. Read on to learn about the tax implications of hiring employees working from another state.
Critical Terms in Employment Taxes of Multistate Remote Work
Understanding the terms defining tax responsibilities for employees and employers is vital for multistate remote work. Although they vary by state, these general definitions apply to most countries' labor laws for remote employees.
- Resident state: where employees live and pay taxes, at least for more than 183 days in a calendar year. Evidence of permanent establishment includes where the employee registers to vote, where their driving license is from, where they rent or buy property, their mailing address, and where their bank accounts are, in most cases
- Non-resident state: the state in which the employee works or commutes to for work.
- Fixed place of business: where an employer has a physical presence in another location (can be temporary) and is often referred to as a “fixed place of business.”
- Payroll taxes: what an employee costs their employer per pay period, consisting of compensation, benefits, and relevant taxes.
- Permanent residents: employees who work and live in a state indefinitely.
- Temporary residents: remote employees who typically work in the same state but are temporarily working remotely in another state with an expected return date.
- Workation: where you work but from a holiday destination of your choice, mixing work and play.
How Are Employees Taxed When Working Remotely From Another State?
When employees work on-site, employers simply need to withhold federal and state taxes and pay payroll taxes according to where your organization is located. For employees working remotely in the same state, the same rules apply for tax purposes. The only thing that may change is local tax obligations, irrespective of whether they earn the same income.
This gets a little complicated when your employees are working in a different state, or when they are working in more than one state. In the US, employees pay state taxes based on their location, not where the organization is. Essentially, employers must pay close attention to their employees’ permanent establishment to ensure compliance with state tax law. Remote workers also want to avoid being double-taxed when paying taxes.
Each state has its own tax rules on how you file taxes and pay state taxes. For example, as an employer in California hiring someone in Oregon, you must withhold federal, state, and local taxes according to Oregon’s labor laws. You would also have payroll tax liabilities accordingly. Nonetheless, there are exceptions, and each state has its own unique rules.
What are Employers Responsible For When Employees Work Remotely From Another State?
While income taxes are technically not part of payroll taxes in the US, we consider them to be for the sake of simplicity. This is purely from a taxation standpoint regarding remote work. In this article, “payroll taxes” is a blanket term for what an employee costs an employer per pay period.
As an employer, you should be aware of the following US payroll taxes and your responsibilities when it comes to withholding taxes for all full-time (or W-2) employees. This includes all employees working remotely from another state permanently.
Employer Federal Responsibilities
Employers must withhold federal income taxes and pay payroll taxes, which consist of:
- Federal Unemployment Tax (FUTA, only paid by employers, aims to provide financial support to individuals with temporary job loss)
- Social Security and Medicare taxes (shared equally between employers and workers and enforced by the Federal Insurance Contribution Act, otherwise known as FICA. FICA assists retirees over 65, children, and those with disabilities in healthcare and hospitalization)
Employers and employees contribute a percentage of the employee’s base salary to social security programs each pay cycle. Employee social security contributions stop once they reach a specific limit.
Employers in the US must contribute 1.45% of income per pay period for Medicare, 6.2% for Social Security, and 6% on the first $7,000 for FUTA on top of withholding federal taxes depending on the employee’s tax bracket.
While there are many things to keep track of, it is worthwhile. Depending on the state that employees are working remotely from, employers could receive tax credits.
Employer State Responsibilities
Employers must withhold state income taxes, where applicable. For example, Washington doesn't have a state income tax and pay but has unique employment taxes and mandatory benefits such as paid family, medical, and sick leave. State-wise, payroll taxes may consist of
- State Unemployment Tax (SUTA, is paid by employers in all states except Alaska, New Jersey, and Pennsylvania, where employees are also required to pay too. Meant to provide financial support to individuals with temporary job loss)
- Disability Fund Tax
- Worker’s Compensation Tax
No State Income Taxes States
In the US, some states do not impose state income taxes. If your employee lives in one of these states, you won't have to worry about withholding state income taxes. There are nine states that do this – Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, Wyoming and New Hampshire.
While these nine states don’t impose a state income tax, they make up for this lost revenue with other taxes or offer fewer public services. Indeed, the cost of living is no lower! For example, Alaska had the lowest tax burden in 2021 but was considered the least affordable state to live in.
Convenience Rule States
In the United States, there's a " convenience rule " designed to simplify taxes for both employers and employees while preventing them from being taxed twice for the same income. These states are Arkansas, Connecticut, Delaware, Nebraska, New York, and Pennsylvania.
For the employer’s convenience: If the employer needs a staff member to work in another state, withholding is only taken according to where the employee works.
For the employee’s convenience: state withholding must be done in both states if employees choose to work in another place but some states have reciprocal agreements so employers can avoid double taxation.
Reciprocity Agreements and Multi-State Worker Agreements
The US reciprocity agreements allow employees to only have to pay taxes on their employment earnings to their resident state instead of their work state if they’re not in the same state. Social security taxes are not within the scope of a reciprocity agreement.
The Multi-State Worker Agreement (MSA), on the other hand, governs both social security taxes and the state taxes levied on an employee’s employment earnings. However, under a standalone reciprocity agreement, if an employee’s home state’s tax rate on their employment income is higher than that of their work state, without the MSA, they’ll not be able to claim a tax deduction on the difference.
If both agreements are in effect between the two states, the employee would be eligible for a tax credit on that difference and would also only need to pay social security taxes once (withheld only by their home but not work state). This means that a reciprocity agreement can exist without an MSA but not the other way around and, this is why these two agreements usually work hand in hand to address the tax conditions of an employee who calls one state home but works in another.
5 Common Remote Work Scenarios Resulting in 2 Different Applications of Employment Taxes in the US
- An employee lives and works in Arizona, their employer’s place of business.
- An employee lives in New Jersey (NJ) but is occasionally required to travel to Arizona to work. Both states share the same employment agreements.
- An employee lives in NJ but chooses to remotely work in Illinois. Both states share the same employment agreements and the employee performs work in Illinois for more than 30 days, returning home a few days after a month has passed.
- An employee living in NJ chooses to work remotely in New York State but returns home in less than 14 days. The states do not share the relevant employment agreements.
- An employee living in NJ chooses to work remotely in New York State but returns home in more than 14 days. The states do not share the relevant employment agreements.
From a taxation perspective, the first, second, third, and fourth scenarios are identical. As long as both states share a reciprocal agreement in addition to an MSA, the employee will only owe taxes to their home state.
As the third example demonstrates, the amount of time that an employee has worked in a non-resident state is irrelevant as long as the two states share both agreements. In situations where two states do not share both agreements, the employee is safe from double state taxation if they do not exceed the time threshold of the state they choose to work in, as seen in the fourth case. This means that an employee cannot exceed a set number of days in their chosen state if it does not have both agreements in place with their home state, as the fifth instance demonstrates.
All in all, employers should check with each state you have employees in to see what taxes you are responsible for. These labor laws for remote employees and their interpretations only apply to full-time employees who are working remotely from another state, not contractors who are working remotely from another state or employees temporarily working remotely in another state. On that note, make sure that you classify your employees and contractors correctly to avoid the risk of misclassification which may complicate multistate remote work even more.
Important Implications of Multistate Remote Work to Remember
Now that you know the nitty-gritty of taxes, here are five important implications you should know four important implications of multistate remote work and their benefits as while as consequences of non-compliance.
Consequence: Creating a Nexus
When employees work remotely from another state without telling their employer, this can create a Nexus. This is a problem for the employer because they will face additional state taxes owed to the state where their employee lives. This is often a surprise that employers didn’t know they had to pay. Therefore, working remotely from another state could result in unintended tax penalties for employers, especially for small businesses.
However, this is not as important for big companies since they usually have established tax relationships with other states. Nonetheless, it is good to know where your employees are.
Consequence: Dual Residency
Employees could also face double taxation when dual residency occurs. You could get taxed for different parts of the calendar year, depending on where you lived and when. When your location is unclear, multiple states can claim their right to tax a portion of your income. Payroll taxes could also be impacted when employees are working remotely from another state. Ultimately, employees should declare their resident state to make withholding state and corporate taxes easier.
Benefit: Reciprocity Agreements
Not all states are out there for your money. Some states have agreed to reciprocity agreements. These are contracts between states that allow residents of one state to work in a neighbouring state without having to file non-resident tax returns. This could come in the form of a tax credit, for example. This is particularly beneficial for those who commute across the border for work and remote workers living at the border.
Benefit: Lower Taxes in Tax States
Some states tax more than others, as we’ve seen above! In states where there are lower or no taxes, employers don’t have to withhold as much state tax or may not need to bother withholding at all! That’s a win-win situation, especially since employers have less to do per pay cycle.
How Can Employers Stay Tax-Compliant with Multistate Remote Work?
Keep the following in mind when hiring in another state:
- Report the employee’s earnings in your place of business (employer’s resident state)
- Withhold the state tax rate stipulated by your place of business, where applicable
- Communicate with the employee to know where they’re working from
Although there isn’t a specified time limit that an employee can be out-of-province like there is under the bilateral US-Canada Tax Treaty, it should be noted that the employee should not be out of their home state and doing work for more than a reasonable amount of time. They should be working in their home state the majority of the time.
When it comes to multistate working, legal and regulatory compliance may not seem straightforward. Borderless is your partner in finding, onboarding, and managing remote employees and is here to help you navigate the complexities of out-of-state hiring. Book a demo today.
Disclaimer: Borderless does not provide legal services or legal advice to anyone. This includes customers, contractors, employees, partners, and the general public. We are not lawyers or paralegals. Please read our full disclaimer here.
