Payroll is an inescapable responsibility for all businesses worldwide. Whether you’ve got one employee or thousands, everyone needs to get paid the right amount on time — every time.
However, how a business runs its payroll is governed by each country’s local rules and regulations. And if you’re expanding into the US or are a US-based business, you’ll know that every individual state has its payroll laws. These payroll laws tend to vary so much that if you’re paying employees around the United States, you might as well be handling international payroll across dozens of different countries. With all kinds of deductions and withholding taxes to think about for each employee in various states, multi-state payroll in the US becomes incredibly complex and time-consuming.
In 2021, The Mobile Workforce State Income Tax Simplification Act of 2021 was passed to make it less complicated for employers based in more than one state or with employees that don’t always work in the same state as they were initially based. The bill prevents an employee’s wages from being subject to income tax in any state other than the state of the employee’s residence and the state in which the employee is present and performing employment duties for more than 30 days during the calendar year.
Compliance with payroll regulations is paramount, with hefty fines and penalties at stake if you miss a deadline or fail to submit the correct form.
But unfortunately, there are still several scenarios in which the payroll tax steps are unclear to follow. Meaning there isn’t always a definitive answer for employers with employees in several states…
So, how do you know where to start?
Reviewing state-specific payroll taxes
Before we delve into the specifics of multi-state payroll, let’s take a step back and look at the state-specific payroll tax obligations on employers. Whilst federal taxes are still required, they don’t change from state to state, so we’ll stick to those that might catch you out if you’re not aware of each state’s rules.
With each employee’s salary payment, you’re responsible for state tax withholdings, such as state income tax, temporary disability insurance, state unemployment benefits and paid family or medical leave.
Most states require employers to withhold state-specific income taxes from each employee’s monthly wages. However, there are nine states that don’t have income tax or only tax some kinds of investment income. These states also require federal unemployment tax (sometimes referred to as ‘FUTA’), and employers also pay state unemployment tax (or ‘SUTA’). In some states, employers must withhold SUTA from employees’ wages to be remitted to the state.
States such as California, Hawaii, New Jersey and New York also require employers to withhold deductions from employees’ wages to go towards each state’s temporary disability insurance benefits programme, often called the ‘TDI’ programme. And if you’ve got employees in Connecticut, Massachusetts or Rhode Island, you’ll have to withhold and remit paid family and medical contributions from your employees’ monthly salary payments.
Each state throws up a unique set of payroll taxation rules for employers to consider. Some will be straightforward — some won’t be. But either way, if you’re paying employees in several different places across the US, it’ll quickly become a minefield of differing payroll laws to consider.
Understanding multi-state payroll scenarios
Typically, multi-state payroll regulations come into play when a business pays employees who work across more than one state over the tax year or those who don’t live in the same state as their employer’s headquarters.
Both scenarios are becoming increasingly common in our post-pandemic world, where remote work is more popular than ever. But even if you have a single permanent employee that spends one day working in another jurisdiction, they could incur a potential tax liability — presenting a real headache for organisations with travelling employees.
Generally speaking, employers must withhold state taxes for the state where the employee is performing their work, regardless of where their business is based. So, if your employees are dotted all over the US, you’ll likely have to withhold state-specific taxes for multiple states. This is based on the ‘source income’ principle, stipulating that states can tax income earned in their state.
As an exception to the general withholding tax rule, some neighbouring states have ‘reciprocal agreements’ in place. These agreements set out that one state doesn’t require income tax withholding if the neighbouring state’s residents work there (i.e. employers only withhold taxes for their employee’s state of residence, not work). For example, Arizona has a reciprocal agreement with California. So, if you’re a California-based employer with an Arizona-resident employee, you’ll follow Arizona withholding tax obligations.
Businesses must keep track of active reciprocity agreements to ensure they pay the right amount of taxes at the right time and file the correct forms for an exemption from withholding.
If an employee works in multiple states and there’s no reciprocal agreement in place, you’ll have to undertake the onerous task of allocating the correct amount of your employee’s wages to each state where they’ve worked and withhold income taxes accordingly.
When it comes to unemployment tax, employers can follow four ‘tests’ to establish which state the SUTA tax goes to if their employees work in multiple states.
Step one is about localisation of services. If an employee works in one state, SUTA is localised to that state. It’s also localised if they work predominantly in one state and temporarily elsewhere.
If an employee’s services can’t be localised to one state, you’ll move on to step two: does your employee have a base of operations? If your employee has a specific state where they begin work or regularly visit to receive communications, repair equipment or perform tasks relevant to their job, this acts as the base of operations and that state’s SUTA applies.
In the absence of a clear answer, you must consider step three: does the employee work in the same state from which you manage or supervise them? Step four of the test is needed if the answer to step three is no, requiring you to consider an employee’s residence. Do they work in the same state as their residence? If the answer is yes, this is the employee’s covered state.
In rare circumstances, you might not be able to say yes to any of the test questions, at which point you might be able to choose to cover the employee’s service in a specific state.
Simplifying your business’ payroll
The rules around multi-state tax compliance are by no means clear-cut and will require a different approach depending on specific employee situations in your business. With no binding rulebook to follow and a great deal at risk should you get it wrong, multi-state payroll can be a convoluted and demanding process. And if you’re paying workers across the US and other countries worldwide, the complexity only grows.
So, why not outsource your payroll obligations to a global payroll provider like TopSource Worldwide?
Blended with our comprehensive employer of record services, we’ll manage every aspect of your multi-state or multi-country payroll for you — handling any state-specific laws to ensure your business stays compliant. We’ll complete all required salary payments on time with electronic payslips and end-of-year reporting as standard. What’s more, you’ll have access to our global payment solution, which reduces payment complexity, improves compliance and increases the assurance of payment delivery.
Let TopSource Worldwide take the hassle out of multi-state tax compliance and let you focus on running your business. Get in touch with us today for more information about our global payroll services.