Remote Work Taxes: Tax Implications for Out-of-State Employees

If you employ remote workers, you know that remote worker taxes can get complicated quickly. That's especially true if you expand your workforce to include employees in another state.

Because each state has its own laws and regulations, you must stay current on remote work implications for state and federal income taxes, unemployment insurance, and Medicare withholdings. You may also encounter additional implications for workers' compensation, disability insurance, or paid leave, depending on the laws of the states where your employees live and work.

If you plan to hire out-of-state remote workers, here are some critical factors you must consider.

Types of Remote Workers

Payroll taxes for remote employees vary depending on the types of remote workers you have and where they live. You'll need to stay current on which taxes you must withhold and pay, which mandated benefits you must provide, and any additional obligations such as overtime or paid leave.

To determine your responsibilities, start by ensuring you have categorized your remote workers correctly as employees or independent contractors. According to the IRS, an employee is someone whose services and activities are determined by the employer. An independent contractor retains the right to decide what work is done and how it is completed. (It's important to note, however, that employee vs. independent contractor classifications vary by law. The IRS definitions may not necessarily match the classifications under your state’s laws.)

Your basic tax obligations for each type of remote worker are as follows:

• Employees: You are responsible for withholding payroll taxes from a remote employee's paycheck and paying a portion of their payroll taxes. Depending on the state they live in, you may also be responsible for additional withholdings.
• Independent contractors: Contractors are responsible for their taxes, so you won't need to withhold payroll taxes for them. However, you will need to request a W-9, and you will need to complete a 1099 for each independent contractor who received more than $600 in payment during the year.

Remember that misclassifying an employee as an independent contractor could lead to tax penalties.

How Are Remote Workers Taxed?

If your remote workers live and work in the same state as your business, you can breathe a sigh of relief—taxes for remote workers in your state function basically the same as they do for your in-person workforce.

However, if you are managing remote employees in another state or country, you'll need to research the tax laws and regulations in each of those localities. Laws governing taxes for out-of-state employees vary by location, so check with each state's labor and unemployment agencies to ensure compliance.

For international scenarios, most countries require you to have a local business presence before you can hire remote workers. Once established, you must follow local tax laws and regulations.

Are Remote Workers Taxed Twice?

An out-of-state worker might initially be taxed both by their state of residence and by the employer's state. However, when they file their taxes, they will be refunded for unnecessary withholdings. Because this can create a financial burden on the taxpayer, some states have reciprocity agreements that allow out-of-state employees to pay income taxes based on the tax laws in their home state.

Payroll Taxes for Out-of-State Employees

Since tax laws vary from state to state, you will likely have additional tax obligations for employees working remotely in another state. As you research your responsibilities, pay careful attention to:

• State income taxes
• State unemployment taxes
• Local income taxes

State Income Taxes

State income tax laws are unique to each state, so the withholding rates you establish for employee paychecks will differ depending on where your remote employees reside. Make sure you use the suitable tables for every state where you have employees and stay up to date on any changes from year to year.

In addition, each state has its taxing authority. This means you must register with the appropriate agencies in each state and go through the necessary steps and fees to get an ID number to withhold and remit taxes for remote employees.

Note your state’s rules for making deposits, including their timing, the electronic system where deposits are made, and any supporting filing and forms.

To recap, complete the following steps to satisfy state-specific requirements for out-of-state employee taxes:

1. Register with tax authorities in every state where you have employees. You may also need to register with local tax agencies.
2. Withhold appropriate income taxes and file any necessary paperwork. Tax forms, filing dates, and payment procedures will differ from state to state. Be sure you know the laws in each state, including any nuances unique to a local area.

State Unemployment Taxes

Just as every state has its tax rates and laws, each state also has its own State Unemployment Tax (SUTA) rules and regulations that will impact remote employee taxes.

Typically, SUTA is paid to the state where the employee works. If you have a multi-state payroll, you must pay these taxes to each state. In addition, each state sets its own rates and wage base, and you will be required to register for an account with the unemployment agency in that state. As with everything related to taxes, these rates and rules will often change yearly and from state to state.

Of course, there are exceptions. For instance, employees in Alaska, New Jersey, and Pennsylvania are subject to their own taxes, which employers must withhold and remit on their behalf.

Local Income Taxes

Local income taxes add another wrinkle to the challenge of multi-state payroll taxes for remote workers. Pockets of localities throughout many states require additional income taxes to be withheld and remitted. These localities have rules, regulations, and requirements for handling withholdings, deposits, and filings. You are responsible for fulfilling these obligations in addition to state tax requirements.

Remote Work Tax Implications Employers Should Know

You are legally required to withhold taxes for all W-2 employees, regardless of their location. This includes payroll taxes for remote workers in other states or countries. In these scenarios, sending online W-2s is an easier and faster option than mailing a paper copy.

In addition to state and local payroll taxes, you may encounter other remote work tax implications associated with various situations. Factors such as the employee's state of residence, remote work status (temporary or permanent), whether the state has a reciprocity law, and the location of your business may affect taxes for remote workers.

Here are some key scenarios to consider.

Reciprocity Rules and Forms

Some states have reciprocal agreements that allow residents of one state to work in another without having to file a non-resident tax return. This can significantly simplify remote work payroll taxes for employees.

Reciprocal agreements vary from state to state, and each state has unique procedures for employers to follow. For instance, Arizona has reciprocity with California, Indiana, Oregon, and Virginia. In these states, a Withholding Exemption Certificate (Form WEC) is filed with employers to avoid withholding.

How To Set Up Reciprocal Withholding

Your employee should request and complete a withholding exemption or non-residency certificate from their state's tax agency. This will excuse them from tax withholding in the state where your business is located. Once they've completed and submitted the form, maintain it in your records. You don't have to submit the certificate. If you work with a payroll provider, let them know that your employee has completed a certificate so they can withhold the correct amount in the employee's state.

"Temporary Presence" Rules for Remote Workers

Laws for employees who are working in a state temporarily may carry complex tax implications for remote workers. Known as "temporary presence" rules, these laws are unique to each state, and it will take ongoing research to stay current on them so that you can correctly withhold taxes. For example, withholding requirements may kick in after a specified number of days worked in the state or a specific dollar amount of earnings.

"Convenience of the Employer" Rules

A few states have "convenience of the employer" rules that require remote workers who live in another state to pay taxes to the state where the employer is located. The exception to this rule is when an employer requires the employee to work out of state. In this scenario, remote work taxes are based on the employee's place of residence.

States with variations on this rule include Connecticut, Delaware, Nebraska, New Jersey, New York, and Pennsylvania. If your business is in one of these states and you have out-of-state workers, ensure you know your state's remote work tax implications.

Workers' Compensation for Remote Employees

Employers need to follow requirements regarding workers' compensation insurance for remote workers. This may mean that additional states will need to be added to your workers' comp policy for each location you have workers.

In work-from-home scenarios, it may not always be easy to document whether an injury or illness was work-related as required by workers' compensation. A good rule of thumb is to talk to your employee about the incident and document all details before submitting to your insurance carrier for review. Requiring employees to have a dedicated work area with defined working hours can also help maintain clear lines between work and personal activities.

Remote Employee Health Benefits

Like remote work taxes, group health insurance plans and benefits are regulated by state law (exception for self funded and level funded benefit plans). But what happens if your employee works in another state or moves to a new location?

First, stay current on healthcare and benefit requirements in each state where you have remote workers. These may include paid family leave, maternity leave, or other state-mandated benefits. If an employee moves to a state where you do not already have remote workers, you will need to research and document the relevant laws and requirements.

Second, be aware that you are required by law to follow the legal requirements for the state where your employee lives and works. This means you will need a way to know when employees change locations. For example, if you have not already done so, institute a policy that requires employees to notify you if they plan to change locations so you can maintain compliance.

Don't Forget Employment Laws

Employers must also be aware of the applicable employment laws that impact their employees, including but not limited to minimum wage, employee leave, overtime, and pay frequency. As with remote employee taxes, the employee's location impacts which laws and regulations are applicable.

Reduce Tax Mistakes With Help From Paychex

Multi-state payroll taxes are complex and getting them right often requires a hefty investment of time and research. Putting the correct in-house systems in place is hard enough, but keeping up with the different state rules, rates, and forms relevant to remote working and taxes can get overwhelming quickly. These complex requirements can easily lead to avoidable errors, costly mistakes, and a great deal of wasted time.

To reduce these risks, many small businesses hand their payroll administration and payroll taxes off to an expert service provider once they expand their workforce to multiple states. Partnering with a payroll provider takes the burden of staying current on nuanced laws and requirements for remote work and taxes off your plate, giving you the freedom to focus on growing your business instead.