Payroll Taxes for Out-of-State Employees

  • Accracy
  • 26th Nov, 2023

Many jobs require an in-person presence. For example, you probably won't see a remote work listing for a forklift operator or a basketball arena announcer. Yet as the pandemic made remote settings more common, businesses must now consider work out of state taxes for employees when doing payroll—in other words, payroll taxes for employees who live in one state, but work in another.

Payroll Taxes for Out-of-State Employees
Tax Tips

How payroll taxes for out of state employees work

Typically, a business owner must withhold state taxes and register with each state tax department where employees perform work. This process is relatively simple if everyone is in one state. For example, if your office and all your employees are in Illinois, you'd file taxes using Illinois tax withholding for everyone.

Things get more complicated with remote workers and out-of-state employees. If one employee lives in Wisconsin but commutes to work every day and works from the Illinois office, you'd withhold taxes in Illinois. However, if that employee lives in Wisconsin and does all their work in Wisconsin—either from home, another office, or an offsite area—you'd withhold payroll taxes in Wisconsin.

The general rule is workers are taxed based on where they perform their work. However, neighboring states sometimes have reciprocal agreements, allowing companies to withhold taxes for the state an employee lives in. That Wisconsin resident could instead pay Wisconsin taxes since there's a reciprocal agreement with Illinois.

For employees that bounce around the country more frequently, you'll need to consider the requirements of each state they work in during your tax preparation and whether there's a reciprocal state tax agreement.

Each state has unique thresholds for how you pay income tax. Some require an employee to work a certain number of days in the state to qualify, while others look at wages earned by the employee to determine if payroll taxes must be withheld. Check each state's tax laws so you're not missing any payments or skipping over potential tax liability. You may also qualify for a tax credit or exemption.

Payroll taxes make up 15.3% of an employee's gross taxable wages. As a business owner, you must pay FICA taxes, including Social Security and Medicare. Those taxes are split 50/50 between the employee and the employer and you'll report them on federal tax forms in each tax year.


How to register with state tax departments for payroll tax

Payroll taxes occur at both the federal and state level. You'll need to understand both levels if you have employees.

First, apply for an Employer Identification Number from the IRS. This step is a requirement for any small business that pays employees. Thankfully, it's a simple process.

Next, you'll get a NAICS Code number for your business, which classifies companies by both industry and business specifics. Here's a list of all the codes. For example, real estate rental and leasing companies are under code 53, while commercial and industrial machinery and equipment rental and leasing is under the longer code 5324.

After you've got your EIN and NAICS Code, it's time to focus on the state level, so register your business with your state's tax agency. Each state has its own rules for payroll and employment taxes. For example, rules that apply to a business in California differ from those in Virginia or Maryland. In many cases, you'll apply at your state comptroller's website. Keep your EIN and NAICS Code handy, and you may also need your corporation number, which you can obtain from the secretary of state.

You'll also need to register for both workers' compensation insurance and unemployment insurance. Most states require employers to pay workers' compensation insurance in the event an employee can't work.

You'll typically register for workers' compensation insurance with your state's department of insurance. Meanwhile, your state's workforce or employee agency can help settle your unemployment insurance. Both types of insurance are applied to employee paychecks, so take care of them as soon as an employee starts in a new state.

Withholding income tax for out of state employees

Whether you compensate employees weekly, bi-weekly, or monthly, you'll withhold state incomes every time you pay them. These state income taxes are in addition to the payroll tax you withhold.

You'll send those taxes to the state via paperwork that details how much income tax you withheld. You'll either use Form 941 or Form 944 to report your federal income tax return on a quarterly or annual basis.

When you register with each state's tax or unemployment agency, you'll receive information on the unemployment tax rate and instructions for paying state tax returns around unemployment. Again, these vary from state to state, so get clear instructions from each state where you have working employees.

One important distinction: Independent or self-employed contractors, whether remote or nonresidents, are not salaried employees. You don't need to withhold payroll taxes from their pay. Instead, you'll send them Form W-9 at the start of their contract to collect their taxpaying details. Then, you'll file a 1099 with the IRS and send Form 1099-MISC by January 31 each year with the total amount of money you paid them the previous year.

Additional out-of-state employee information

A growing company is cause for celebration. You're selling more products, making more money, and providing more jobs. But those jubilant cheers will quickly turn to frustrated groans if you're unprepared with your payroll taxes.

Here are other considerations to ensure your organization's growth remains seamless for both you and your out-of-state employees: Minimum wage: The federal minimum wage is consistent across the country, but some states also have state or county minimum wages. You must pay employees at or above whichever minimum wage is highest.

Pay frequency: Each state has unique rules for how frequently you can pay employees. Some states only offer twice-monthly or monthly payments. Others allow more frequent payroll distributions.

Withholding local income taxes: If your employee works in a city or county without a local income tax, you don't have to pay it. However, it's mandatory to withhold local income taxes if your employee's city or county does require it.

State disability insurance: If your employee works in California, Hawaii, New Jersey, New York, or Rhode Island, you must withhold money from their paycheck for state disability insurance.

Workers' compensation insurance: Many states require workers' compensation insurance, factoring in your company's size and industry. Check with each employee's state department of insurance—while a Pennsylvania business has to pay workers' compensation insurance, states such as Texas don't require it.

The bottom line

Payroll is one area of your business you can't afford to get wrong. But it can be a complicated process, so having a good payroll system in place is essential. We've compiled the top ones here to get you started.

No matter where your employees are across the country, or even if you hire nonresidents internationally, you'll need to keep detailed and accurate records for your business. Accracy is happy to help.

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