If an employer has operations in more than one state, income tax might need to be withheld for multiple states. In fact, at times the employer might need to withhold income tax for multiple states from the wages of one employee. Withholding can become complicated when an employee lives in one state and works in another or performs services in more than one state.
Employees Are Where?
The American Payroll Association’s report, “Employees Are Where? Presence, Nexus, and Employment Taxes: A Payroll Analysis,” is designed to help payroll professionals, their employers, and government policy-makers understand the compliance challenges with multi-state taxation and business nexus. Data shows a dramatic shift in employee work locations to hybrid and remote work raising interest addressing the challenges.
Which state income tax to withhold
As a starting point, the default rule of state income tax withholding is to withhold income tax for the state in which services are performed (the work state). Almost all states require employers to withhold tax from employee wages earned for work performed in that state, even for nonresidents. The analysis need go no further if the employee lives and works in one state. Also remember withholding is not required for the nine states that do not have a state income tax: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.
An employee’s state of residence must be determined because a resident is subject to the laws of that state, including its income tax laws. States have the power to tax all income of state residents, even income earned for work performed in a different state. State definitions of residency vary, so state laws and regulations must be consulted when making the determination.
An employer might be required to withhold income tax from wages for an employee’s state of residence – even if the employee does not perform services there – if the employer has a business presence or operations in that state, also referred to as nexus. The presence of a business location, such as an office, store, or factory in the state will create nexus there, as will the mere entry of an employee to make a sale or perform a service call. Additionally, an employee working remotely from his or her state of residence on an occasional basis might be enough of a business presence to create nexus.
During the COVID-19 public health crisis, many state tax agencies have issued guidance waiving nexus during the emergency period if it would have been established by the presence of resident employees working temporarily from home solely due to the pandemic. Most state guidance goes on to say nexus might be established in the future if the remote work continues beyond the emergency period. See the COVID-19 Payroll Resource Center for additional information.
When two states have a reciprocal agreement for tax purposes, it makes things administratively easier for the employer by allowing it to withhold only for the state of residence.
Employees Working in Multiple States Without Reciprocity
If an employee works in multiple states that do not have reciprocity with the employee’s state of residence, then the laws and requirements of both states must be considered. The employer might need to withhold state income tax for both the work state and the state of residency.
Double taxation is not prohibited by the U.S. Constitution as long as it is not arbitrary, but most states help residents avoid double taxation via a variety of methods, including reciprocity agreements, allotment or apportionment rules, and credits for taxes paid to other states. Some methods will affect whether the employer is required to withhold for each state and the calculation of the amount to withhold for each state.
State nonresident taxation thresholds
Some states do not require an employer to withhold tax from employee wages until an employee has met a certain threshold number of days worked or an amount of wages earned for services performed in the state. States have inconsistent, differing requirements (see the Guide to State Payroll Laws §3.1). Typically, once the threshold has been met, the employer must withhold from the commencement of services performed within that state. Because retroactive withholding can be complicated, some employers begin withholding from the commencement of services in a state.
Mobile workforce issues
When an employee travels for business and performs work in a state other than the employee’s usual work state, withholding requirements become even more complicated. Employees who work in multiple states are potentially subject to state income tax in every state to which they have traveled for business, even if they performed services in that state during only one day.
PayrollOrg is part of the Mobile Workforce Coalition, a group advocating for passage of federal legislation to establish a uniform threshold for state taxation of nonresident income. The legislation has been introduced a number of times since 2006.
In general, proposed legislation would establish a 30-day threshold, meaning an employee’s wages for services performed in a state would not be subject to income taxation in that state until the employee is present and performing employment duties for more than 30 days during the calendar year. Employers (with nexus to the state) would not be required to withhold until the threshold has been met.
In addition to several proposed bills similar or identical to the Mobile Workforce Coalition’s model legislation, a recently proposed COVID-19 relief package includes a provision that would establish a uniform 30-day threshold for state taxation of nonresident income. During the pandemic, the threshold would be extended to 90 days. Links to proposed federal legislation are provided below.
PayrollOrg actively submits statements and urges lawmakers to vote for its passage. Links to statements and letters are under Government Relations below.
Mobile Workforce Issues
- August 27, 2020: Letter to the House and Senate in support of Section 403 of S. 4318, American Workers, Families, and Employers Assistance Act, and S. 3995, the Remote and Mobile Worker Relief Act of 2020.
- June 29, 2020: Letter to congressional leadership supporting S.3995, Remote and Mobile Worker Relief Act of 2020.
- June 29, 2020: Letter to U.S. Sens. Thune and Brown supporting S.3995, Remote and Mobile Worker Relief Act of 2020.
- April 17, 2020: Letter to state tax administrators and commissioners with APA’s request to expand existing emergency responder tax exceptions for all employees temporarily teleworking in their home state because of COVID-19.
- April 17, 2020: Letter to state tax administrators and commissioners with APA’s request for COVID-19 relief for employees temporarily teleworking in their home state.
- March 31, 2020: Letter to Kansas House Committee on Taxation in support of H.B. 2722, which would establish a 30-day safe harbor from income tax withholding for nonresident employees who travel into Kansas to perform work.
- March 31, 2020: Letter to Minnesota House and Senate Committees on Taxes in support of H.F. 4128 and S.F. 3188, which would establish a 30-day safe harbor from income tax withholding for nonresident employees who travel into Minnesota to perform work.