Do You Have an Employee in Another State? What Your Business Needs to Know

As your business grows, you may find yourself hiring employees out of state. While growth is great, keeping up with the payroll compliance in each state can feel like trudging through murky waters. States have varying requirements related to withholding income tax and paying unemployment tax.  Additionally, states have increased their tax compliance efforts over the years making it even more necessary that employers be aware of their responsibilities. So, if you have an out-of-state employee, here’s what you need to consider:

Where does the employee work?

Generally, you are required to withhold income tax and pay unemployment tax in the state in which the employee physically works. Makes sense, right? But it’s not always so straightforward. If your employee travels into several states, you need to be familiar with each state’s requirements. Some states require withholding from the first day an employee works in the state while other states have thresholds (minimum numbers of days or minimum amount earned) that determine when withholding is required.

If your employee works in one state but lives in a neighboring state, he or she may have to file tax returns in both states. However, if the two states have entered into a reciprocal agreement, the employee would only need to file in the resident state.

What is a reciprocal agreement?

Some states have formed reciprocal agreements, which exempt employees from paying income tax on wages earned within the state if the employee lives in a bordering state. That means that wages are only taxed by the employee’s resident state. This simplifies compliance for the employee, who would otherwise be required to file income tax returns both in the resident state and the state in which the wages were earned.

What is a reciprocal exemption?

When an employee has a reciprocal exemption, the employer withholds income tax in the employee’s resident state but generally pays unemployment tax to the state in which the wages were earned. For example, consider an employee working in Illinois but living in Michigan. The employer would report the wages as Michigan wages on the payroll withholding reports, but the wages would be reported as Illinois wages for Illinois unemployment tax reports.

What else should I consider with employees in other states?

Payroll taxes are an obvious consideration when you have employees working in other states. You will also need to consider other workforce requirements of each state, including:

  • Minimum wage, overtime, and equal pay requirements
  • Employee rights posting requirements
  • State disability requirements

Additionally, be sure your workers compensation policy includes all employees, even those working remotely. In the case of remote workers, be sure to inform your workers compensation company of the employees’ duties, work area and work hours.

Asking yourself these questions is the first step in being compliant with the states and also providing the best possible state withholding for your employees. Cray Kaiser is available to assist you when these issues come into play. Please contact us anytime at 630-953-4900.