For businesses that have operations in multiple states or that employ residents of other states, navigating the applicable payroll taxes can be a nightmare. Each state has its own set of laws for payroll taxes, and employers are responsible for knowing and adhering to these laws.
In addition to withholding the proper amount for federal taxes, companies must also withhold the appropriate amount of payroll taxes from employee’s paychecks for state income taxes. The following are some of the most common pitfalls businesses face when paying taxes in multiple states and how to avoid them.
Residency Laws of States Employees Live In
The residency of employees must be established before looking at any specific payroll tax laws, because the residency of an employee determines what laws, including income tax laws, the employee must follow.
Most employees are residents of the states they live in, but not all cases are this simple. Residency is typically determined by the number of days an employee spends in a state, but the precise amount of time varies from state to state.
A few special circumstances where employees are residents of a state they do not work in include (but are not limited to):
- College students working during the school year
- Seasonal employees at resorts
- Employees that relocated for a position
Employees are responsible for paying income tax in the state of which they are a resident. (Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming do not have income taxes).
Tax Laws in the State of Service
Many states also have payroll tax laws in place for service performed in the state, even if it is performed by someone whose residency is in another state. States want to benefit from the commerce that takes place within their borders.
Businesses that have employees travel to the business’ location from another state must follow these laws, as must businesses that send employees across state borders.
Some common situations where the state the service was performed in is different from an employee’s state of residency are:
- Truck drivers that deliver goods across state lines
- Consultants that fly in from another state
- Public speakers that lead conferences and seminars
- Salespeople with territories outside their state of residence
- Employees and businesses located close to a state border
Like residency laws, the payroll tax laws that are applicable in these situations vary. Some states’ tax laws let employees work for a few days in a state, before the payroll taxes go into effect. Other states begin taxing workers as soon as they enter the state. This means an employee may pay tax in multiple states.
Agreements of Reciprocity
Businesses must keep track of two (or more) different sets of payroll tax laws for each employee that works and lives in a different state. Businesses must adhere to the tax laws from the state of residency and those of the state that the work was performed in.
Many states, though, have agreements with reciprocity with other states. These are usually found in areas where people and businesses regularly cross state lines.
In situations where the two states have a reciprocal agreement, businesses only need to withhold payroll taxes for the state of the employee’s residency.
For instance, an employee who lives in Washington D.C. and works in the District of Columbia, Maryland and Virginia only has to pay the District of Columbia’s income taxes.
Reciprocal agreements can be very specific. The states that have them (many do not) tend to only have an agreement with nearby states, and they are not necessarily mutual.
For instance, Arkansas has an agreement that Texarkana, Arkansas residents do not have to pay Arkansas’ state income tax, nor do Texarkana, Texas residents who work in Texarkana, Arkansas.
This agreement, though, does not apply to either state’s residents who live or work outside Texarkana, and Texas does not have this agreement. This is just one example of how exact reciprocal payroll tax agreements can be between states.
Monitoring all the Details
In sum, businesses are responsible for knowing:
- The tax laws of their employees’ states of residence
- The tax laws of the states in which the business operates
- The relevant reciprocal agreements between states
For small companies that only have employees who live nearby, payroll taxes may be fairly simple. Larger companies that either serve customers in other states or have employees in other states, though, must vigilantly monitor these details for each of their employees.
Any time an existing employee moves or a new employee is hired, the details become slightly more complex. In large corporations, keeping track of all the regulations quickly becomes a full-time job.