Hiring remote employees opens up the talent pool and potentially lowers office costs. But when your remote employee lives in another state, there are important tax implications to keep in mind as you set up payroll.
In this article:
- When hiring remote employees, companies are required to withhold and remit state and local income taxes to the appropriate agencies. But determining a remote employee’s state of residence isn’t always easy.
- Five states have a “convenience rule” that can lead to double taxation for remote employees.
- A remote employee’s state of residence also potentially influences a company’s federal unemployment tax credit reduction.
State and Local Income Taxes
State Income Taxes
When hiring a remote employee who lives in another state, you’ll need to withhold income tax for your employee’s state of residence. You’ll also need to register with the appropriate state agency in order to remit these taxes.
So how do you determine a remote employee’s state of residence?
As with all things taxes, the answer isn’t always neat and tidy.
First, there are two important concepts that influence this determination: domicile and residence.
To be domiciled in a state, your remote employee has a “true, fixed permanent home” there. However, if your remote employee spends a period of time in another state — with time thresholds defined by each state — they may be considered a resident, and therefore owe state income tax to both states.
For example, some states, like Colorado, require state income tax withholding, even if your remote employee works for one day in that state.
As the employer, the responsibility of properly withholding and remitting state taxes falls on you. While you aren’t required to track the whereabouts of your remote employees, we recommend having policies in place that require employees to notify the company when working outside a state where the company is based or has a physical office. These policies should require that this type of work is approved beforehand. Then, you can withhold and remit state taxes where needed.
The Convenience-of-the-Employer Rule
Five states — Connecticut, Delaware, Nebraska, New York, and Pennsylvania — have a convenience-of-the-employer rule.
This means that if you, as the employer, are based in one of these states, your remote employee could potentially face double taxation: owing state income tax to both the state your company is located in and their state of domicile. And as the employer, it is your responsibility to properly withhold and remit these state taxes.
States Without State Income Tax
As of 2023, these 8 states have no income tax:
● South Dakota
Local Income Taxes
In cities and counties across 17 states and the District of Columbia, you’ll find income taxes imposed by local jurisdictions. For example, St. Louis, MO, and New York City both tax personal wages.
If your remote employee works in one of these jurisdictions, you’ll need to register with the appropriate local agencies in order to remit taxes, as well.
Federal and State Unemployment Income Taxes
Federal Unemployment Tax
No matter which state your remote employee calls home, the federal unemployment tax rate is 6.0% — a tax covered by the employer. For companies located in many states, you can then receive a 5.4% credit when you file Form 940, ultimately leading to a net federal unemployment tax rate of 0.6%.
However, this 5.4% credit is reduced in a handful of states.
As the IRS explains:
“Some states take Federal Unemployment Trust Fund loans from the federal government if they lack the funds to pay UI benefits for residents of their states.
If a state has outstanding loan balances on January 1 for two consecutive years and does not repay the full amount of its loans by November 10 of the second year, then the FUTA credit rate for employers in that state will be reduced until the loan is repaid.”
This federal unemployment tax credit reduction is important to keep in mind hiring a remote employee who lives in another state.
State Unemployment Tax
As an employer, you’re not only responsible for covering the federal unemployment tax. You’re also responsible for the State Unemployment Tax Act (SUTA) tax, remitted to the state in which your employee is domiciled. This tax helps cover unemployment benefits to workers who are unemployed through no fault of their own.
The SUTA tax rate is set by each state, ranging from less than 1% to higher than 10%. Factors like industry and years in business play a role in determining your particular SUTA tax rate; typically new businesses and construction companies pay a higher rate.
For example, starting in 2023 in Arkansas, new businesses will be assigned a 3.1% rate for the first three years of business.
Additionally, there’s a wage base, set by each state, for paying this tax. In Arkansas, this wage base is currently $7,000 per employee per calendar year.
However, some states — Alaska, New Jersey, and Pennsylvania — go an extra step, requiring additional withholdings from employees’ paychecks in order to cover the SUTA tax.
Make sure you’re withholding the correct taxes for your remote employees
Improperly withholding state and local income taxes from paychecks can lead to penalties — both for you, as the employer, and for your employee.
But you don’t have to go it alone.
Work with a Landmark advisor to ensure you are correctly running payroll for your remote employees, no matter where they call home.