Multi-State Payroll Tax Withholding: A Guide To Getting It Right
If you’re like most companies today, odds are you have employees who work remotely or from a different state than where your business is located at least some of the time. In these situations, it can be confusing to know where to withhold and remit payroll taxes – and how to do it. To help you get multi-state payroll right, here we’ll break down everything you need to know to avoid penalties and interest.
In this article, we’ll explain the requirements for payroll tax withholding when you have employees who work in a different state than where your business is located as well as steps you can take to make sure you comply with the rules. After reading this, you’ll know how your company can avoid potential issues and costly consequences with state payroll taxes.
What are the types of state payroll taxes?
With each paycheck, you need to withhold and deposit payroll taxes to cover several obligations. At the federal level, these include income taxes, the employee’s and employer’s share of Social Security and Medicare taxes, and FUTA.
But you may also be responsible for state payroll tax withholdings, including:
- State income tax: In the vast majority of states, you’ll need to withhold state income taxes from employees’ paychecks. There are some exceptions, however. Specifically, the following states have no individual income tax or tax only certain types of investment income: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.
- State unemployment benefits: In addition to FUTA, employers typically must pay taxes to fund the state’s unemployment program or SUTA. In many states, SUTA is an employer-only tax. But in some states, like Alaska, New Jersey, and Pennsylvania, you’ll need to withhold SUTA taxes from employees’ wages and remit them to the state.
- Temporary disability: In a handful of states, including California, Hawaii, New Jersey, New York, and Rhode Island, you’ll need to withhold deductions from employees’ wages to fund the state’s temporary disability insurance (TDI) benefits program.
- Paid family and medical leave: Certain states, including Connecticut, Massachusetts, and Rhode Island, have paid family and medical leave (PFML) programs that require employers to withhold and remit PFML contributions from employees’ paychecks.
These withholdings will vary from state to state. To understand exactly what you need to withhold, the first step is determining the correct state for purposes of income tax and the ancillary taxes we just discussed.
How do I determine where to withhold state payroll taxes for employees working out of state?
Income tax is the biggest and most common multi-state payroll tax withholding so we’ll start with that and then address ancillary withholdings.
As a general rule, you’ll use the state where your employee performs work to determine your withholding obligations.
But that’s not always the case. Sometimes, it can be more challenging to figure out what state governs income tax withholdings for individual employees. There are certain situations that are more complicated, such as:
- If the employee resides in a different state than where they work. These workers are called dual-state employees and they typically file income taxes in both the state they reside and work in.
In some cases, there may be reciprocal agreements between neighboring states. This basically just means there is a document stating that one state will not require income tax withholding from the other state’s residents working there. Some examples are Arizona and California or Virginia and Washington, DC. In these cases, you would only report wages to the employee’s state of residence.
- Whether you have nexus in another state based on your presence or connection there. Establishing nexus — which determines whether you’re required to withhold tax for a given state — requires more than just incidental services like an employee going to a meeting across state lines. Generally, it arises when you have workers performing activities in the state that exceed a certain period of time. Individual states set their own thresholds. For example, in New York, it’s 14 days present in the state in a year. If you establish nexus in a state, you will be responsible for withholding income taxes in that state even if you aren’t located there.
- When an employee splits their time and works in multiple states. You’ll need to consider additional steps if you’re withholding taxes for employees working in multiple states. In these cases, when there is no reciprocal agreement, you’ll need to allocate the correct amount of the worker’s wages to each state where they work and withhold income tax accordingly.
So, for instance, if a nonresident employee performs services partly in and out of New York, the number of wages allocable to New York would equal the compensation for the number of days worked in New York compared to the total number of days worked out of the state.
- If a state has specific requirements. For example, in Massachusetts, you must withhold income tax from all residents’ wages for services performed in or out of the state and nonresidents’ wages for services performed in Massachusetts.
Once you know which state you’ll need to withhold payroll taxes for employees working out of state, that location will dictate your rate. When it comes to income tax, the rates are either based on a tax table or a flat percentage. While most states use tables to determine withholding amounts based on an employee’s annualized income and their exemptions, some places, like Pennsylvania, tax everyone at a specific percentage.
For your state’s rules, check with your taxing authority like a Department of Revenue or Division of Taxation. The Federation of Tax Administrators has a list of each state’s tax agency’s website. You’ll want to check every year since the tax tables can change, and you always want to ensure you’re working with the latest versions.
Unemployment and Other Ancillary Taxes
Now that we’ve covered withholding for state income tax, as we mentioned at the beginning, there may be other taxes you need to withhold based on the state.
Unemployment is generally an employer-only tax. But as we explained before, in Alaska, New Jersey, and Pennsylvania, employees will also be assessed a tax. In these states, you’ll need to withhold the state unemployment tax and remit it to the state.
To determine if you’ll need to withhold state unemployment tax in one of these states, you’ll first have to identify your jurisdiction for remitting state unemployment insurance taxes. Usually, you look to the state where the employee performs services. But there are some exceptions, especially when employees work in multiple states. To make the determination in these cases, you’ll need to consider four factors:
- Whether your services are localized in a state
- If your base of operations and some of the services are performed in the state
- If you exercise direction or control in the state
- If these first three factors don’t result in a determination, then the employee’s state of residence is used
An employee’s state for unemployment purposes may also dictate your responsibility for withholding other taxes for paid family and medical leave programs.
For example, Massachusetts has a state-paid family and medical leave program that requires employers to withhold the employee’s contributions for workers whose unemployment state is Massachusetts.
Whether you need to withhold state disability taxes is also tied to the state where you’re responsible for remitting unemployment taxes. So, if your employee’s unemployment state is Rhode Island, you would also be responsible for withholding taxes for temporary disability insurance (TDI) from a worker’s paycheck. Each of the states with TDI programs has slightly different eligibility requirements, so make sure you familiarize yourself with the rules if you need to remit TDI.
What are the multi-state payroll tax withholding requirements?
Once you’ve identified what states you need to withhold taxes for, you’ll need to follow three steps to make sure you’re compliant with the regulations.
- Step 1 - Register: Each state will have its own taxing authority that you’ll need to register with for income tax withholding. Many offer the option to register online. Once you register, you’ll get an ID that you’ll use when you remit the taxes. It’s important to note that, if you have remote workers, you’ll need to register in the state where they work. A good way to identify the jurisdictions is to ask workers to self-identify their locations.
- Step 2 - Calculate State Tax Withholding: We’ll discuss this in more detail below, but you’ll want to reference state rules to determine the withholding amount for workers. Typically, this involves referring to their tax tables or the percentage set by law.
- Step 3 - Make Timely Deposits: Follow state rules for making the deposits and submitting any necessary filings that report how much you withheld. You’ll want to make sure you do this on or before the deposit due date or you risk being penalized.
Getting Your Business’ Multi-State Payroll Right
As you can see, multi-state payroll issues can be pretty complicated, especially when states all treat tax withholding differently. And if you make a mistake and don’t get multi-state payroll tax withholding correct, you can be on the hook for costly penalties and interest as the employer. To avoid financial consequences, our state and federal resources page can give you a solid understanding of the laws to keep you compliant in your local area.