Payroll Issues for Multi-State Employers
Payroll is complex enough for businesses operating from a single location. The difficulty skyrockets when you operate in multiple jurisdictions across state lines. But payroll issues for multi-state employers don’t have to derail your plans to expand your business or hire workers.
With the embrace of remote work, businesses that were extremely localized — institutes of higher education, nonprofits, community banks and engineering firms, for example — are looking for talent in new places, often across state lines.
As you expand your workforce or open offices in new locations, be aware of these payroll issues for multi-state employers — and the best practices that can improve compliance.
Managing Multi-State Income and Payroll Tax Complexity
The biggest payroll issue facing many multi-state employers is tax complexity. When paying employees who are performing work in different states, your business is obligated to withhold both income and payroll taxes from the employee’s wages for the state they’ve worked in. But determining which states to report that income to can be a challenge.
State Income Tax Differences
Income tax requirements differ by state, and payroll professionals have to keep up with the specifics of each. When expanding into a new geography, a business may establish economic nexus, which triggers income tax withholding requirements within that state.
Different states have different criteria for when nexus has been achieved, but generally, sales made or solicited within the state constitute economic nexus, as does having employees working in the state. Your business is obligated to withhold income tax in the state that the employee lives and works in.
If you have an employee working remotely from their home in Arizona, for example, you’ll withhold income tax for that state, even if the bulk of your business is located in another state. And when taxes are due, the employee will file a tax return with the state of Arizona.
Working Across State Lines
Multi-state payroll compliance becomes more complex when individual employees work across state lines. When an employee lives in one state but performs services in another, payroll professionals have to determine which states apply for withholding tax from the employee’s paycheck.
Generally, working across state lines requires employers to withhold income tax from both the employee’s state of residence and their work state. The employee won’t pay taxes for both, however; when filing their income tax returns, employees can typically get back the income tax paid to their nonresident state.
Some states, however, have reciprocity agreements with other states. When the state where the employee lives has a reciprocity agreement with the state where the employee works, employers only have to withhold income tax for the state where the employee lives. Income tax collection will be waived by the state where the employee works.
Reciprocity agreements are most common for states that share a border, allowing an employee who lives at the edge of one state to work in another state without being taxed twice for the same work. An employee who lives on the northern border of Illinois, for instance, can commute to a job in Wisconsin — which has a reciprocity agreement with Illinois — without having Wisconsin income tax withheld from their paycheck.
Reciprocity agreements aren’t triggered automatically. Employees have to file a certificate of nonresidency with HR in order to have taxes waived in the state where they work. Provide education to employees to help understand how to request a tax waiver. For employees who cannot benefit from a reciprocity agreement, educate them on how to file their tax returns to get back the taxes collected by the nonresident state.
Unemployment Insurance Tax
Withholding requirements for unemployment insurance tax vary by state. When employees operate across state lines, employers only need to report unemployment insurance tax to one state. But determining which state can be challenging. Employers must evaluate several factors:
The first factor, localization, refers to the location where services are performed. If the employee only works in one state or spends a clear majority of the time in one state, you’ll report unemployment insurance tax to that state. If an employee’s work is divided across two states, then use the base of operations to determine where to report unemployment insurance tax.
Base of Operations
The second factor, base of operations, typically refers to the place where the employee receives assignments and instructions. If the employee performs their work in the same state where the base of operations is located, that is the state where you report unemployment insurance tax.
Place of Direction and Control
If there is no clear base of operations or the employee doesn’t perform services in the state where the base is located, refer to the employee’s place of direction and control, which is typically company headquarters.
Finally, if the employee doesn’t perform work in the same state as their place of direction and control, then defer to the employee’s state of residence for reporting unemployment insurance tax.
Develop a checklist for ascertaining which state to pay unemployment insurance tax to.
Multi-State Payroll Taxes
Beyond income tax, multi-state employers also have to manage differences in payroll tax requirements. Payroll taxes are fixed-rate items, typically pertaining to coverage for employee leave, such as short-term disability benefits and family and medical leave. The amount you’re required to withhold for each of these items can vary by state, and some states may require employers to match employee contributions.
Handling State-Specific Payroll Requirements
There are additional state-specific payroll requirements that can pose a challenge to your payroll administrators. Watch out for these items when processing multi-state payroll.
There are different wage-and-hour requirements for working overtime in different states. Determining what goes on the employee’s paycheck when overtime hours are worked depends on the state where services were performed. Many states defer to federal regulations, but some, such as California, have stricter guidelines for paying overtime to employees.
Leave of Absence
Leave of absence is governed by a patchwork of laws across the country. Many states and some local jurisdictions are adding their own leave laws to the mix. This is an area of constant change that employers must monitor to maintain multi-state payroll compliance.
Several states require employers to offer paid sick leave to employees. These requirements might pertain to the entire workforce or only to certain qualifying employees. Additionally, mandatory sick-leave laws may only require a certain number of hours worked. It’s up to you to decide whether to offer more than what’s required by the states in which you operate.
Working With Outdated Payroll Processes and Systems
Among the greatest issues facing payroll professionals today is operating with outdated processes and systems. As employment norms have changed, so has our need for updated and standardized payroll processes.
Scaling Up Payroll Processes
To avoid payroll tax issues, develop standard payroll process guidelines for your business regardless of location. Guidelines are less about specific actions and more about making choices in line with legal requirements and company values. They’re a flexible option for bringing consistency to your payroll processes.
Work with key stakeholders to develop functional payroll guidelines for your multi-state enterprise. Here are some of the people who can help:
- HR leaders can help you develop a repeatable process that aligns with your business philosophy, values and the other HR processes in your organization.
- Finance and accounting leaders can contribute expertise around payroll practices and tax laws in each jurisdiction where you have employees.
- Local payroll administrators will be carrying out your processes on the ground, so they need to be included in the design phase. They’re most likely to have innovative ideas for practical guidelines.
- Your payroll partner, if you have one, likely already has experience working with multi-state employers. These experts can advise on best practices and help you customize payroll processes and guidance that meet your unique needs.
With the right team in place, you can develop guidelines for scaling up payroll processes while ensuring compliance — no matter where your employees are operating from.
Managing Data Across Systems
Your payroll data may be stored across several systems, which can lead to errors related to missed or duplicated data. This can make managing payroll across a multi-state enterprise especially challenging.
Having all of your payroll data stored in a central HCM can provide a single source of truth, which can stave off errors before they arise. You can get an accurate picture of your payroll processes at a glance. Use that visibility to make changes to improve processes, use of the system and compliance.
With so much complexity, payroll issues for multi-state employers can pose a great risk to your compliance. But when you’re aware of the risks, you can put an effective plan into place to anticipate and overcome them. Evaluate these issues for any states you’re interested in hiring from or expanding into. By monitoring and addressing these payroll issues, you can reap the greatest rewards with the lowest risk.