Many companies are expanding their business transactions across state borders and finding themselves operating with a mobile workforce. With many states aggressively attempting to find ways to close their budget deficits, these expanding companies become a means of generating new sources of revenues. Compensation to employees is generally taxable in the state where it is earned, making it necessary for companies with a multi-state workforce to consider both the state income tax withholding and unemployment tax laws of multiple states.
State Income Tax Withholding
The general rule of thumb for states that have an income tax is that employers are required to report wages and withhold tax from the employee’s earnings for the state where the underlying services are performed. This general rule applies to most situations where the employee works and lives in the same state. However, in today’s mobile business environment, three additional rules may need to be considered pertaining to employees:
- Residency Rules – Attention needs to be given to how a particular state defines residency in order to properly determine withholding requirements. Most states define residency based on either an individual being domiciled in the state or a threshold of spending more than a number of days in the state.
- Reciprocity Rules – Some states have reciprocal agreements with other states to allow withholdings in the state of residence rather than where the work is performed. These agreements need to be reviewed annually as they frequently expire or change.
- Resident/Non-Resident Rules – If reciprocity does not exist between the states, then the withholding rules of both states must be considered when an employee works in a state other than one they reside in. In this scenario, the ordering is to consider the work state first and then the resident state. If the resident state’s withholding requirement is higher than the work state, then the excess would be withheld and remitted to the resident state. This reporting scenario will necessitate multiple states withholding being reflected on the employee’s W-2. Whether or not the employer has nexus in a state must also be taken into consideration for withholding purposes. Outside of honoring a reciprocity agreement, an employer that does not have nexus in the employee’s resident state is not required to withhold income tax for the state where the employee resides.
Although there may be multiple state income tax withholding requirements for the same employee, unemployment tax is only paid to one state per employee. To determine the state that the wages are reported to for unemployment tax purposes, all states follow the same four-pronged test outlined below:
- Localized Services – Where is most of the employees’ work completed?
- Base of operations – Where is the employee headquartered?
- Where is the place of direction and control of the employee?
- If a state has not been identified by the above three prongs of the test, then the employee’s state of residency is to be used as the reporting state for unemployment tax purposes.
On March 7, 2017, a mobile workforce bill was reintroduced to the U.S. House of Representatives and the U.S. Senate. H.R. 1393, the Mobile Workforce State Income Tax Simplification Act of 2017, creates a uniform standard that only non-residents who work more than 30 days in a single state are subject to that state’s income tax withholding requirements. The bill was passed in the House of Representatives on June 20, 2017, and now goes to the Senate for consideration. Previous mobile workforce bills have repeatedly died in Congress and how far this legislation advances remains to be seen.