Many businesses have team members across state lines, and you may have clients with remote employees in other states. Payroll can get confusing and tricky in those situations! Here are some considerations employers should think about when understanding payroll requirements for remote workers.
1. What are the typical employment-related taxes an employer must withhold and/or pay for remote employees?
Essentially, employers must withhold and/or pay the same types of taxes for out-of-state employees as they do for in-state workers:
- Federal income tax;
- FICA (Social Security and Medicare);
- FUTA (federal unemployment);
- State income tax;
- SUI – a.k.a. SUTA (state unemployment insurance);
- Local income tax; and
- Other state or local payroll taxes (these vary by state).
While this may seem straightforward for accounting and payroll professionals, there’s a twist. See consideration 2.
2. Which state’s payroll tax laws must an employer follow if a remote employee works in a different state than where the employer is located?
When an employee doesn’t live in the same state as their employer, the payroll taxes of the jurisdiction where the employee lives and works apply. So, if an employer has a remote employee located across state lines, it must register to report and pay payroll taxes in the employee’s state. For example, if ABC Flooring Solutions in Alabama hires a remote employee in Georgia, the company must register for payroll taxes in Georgia. Keep in mind that in addition to state employment taxes, some local governments may have payroll tax laws, too.
3. If a business has an employee in a different state, does it need to foreign qualify in the employee’s state?
Besides registering for payroll taxes, an employer might also have to file for foreign qualification in the state where a remote employee lives and works. Foreign qualification means the company is registered as a foreign entity in a state beyond its home (domicile) state (where it filed its formation documents). The requirement to foreign qualify depends on whether the employer has nexus — an economic or physical presence — in the employee’s state.
If a company has nexus and must foreign qualify, it must then comply with the business compliance requirements in that state. Examples include obtaining and renewing licenses and permits, filing annual reports, paying state income and sales tax, etc.
4. What determines if an employer has “nexus” in other states?
Economic nexus may occur when a company generates revenue in a state (which can occur even if no physical office or employee exists there). States’ rules vary for what constitutes economic nexus, but generally, these two methods determine whether it exists:
- Cost of performance sourcing — Where the most cost/labor is generated to produce the revenue; and,
- Market-based sourcing — Where the benefit of the product/service is received.
Many states have thresholds set for when economic nexus is established. Some determine a company has nexus upon reaching revenues that exceed a specific dollar amount or a specific number of sales transactions.
Physical nexus can mean an employee was hired in a state to generate revenue, or the employer has an office, warehouse or store in the state. Nexus rules vary by state, so it’s important that businesses research, understand and comply with the laws in any state where they’ve hired remote employees.
5. Can employers that don’t have state-registered business entities (sole proprietorships and general partnerships) hire remote employees in other states?
Yes, they can. Just like LLCs, corporations and other entities, they must complete payroll registration in any state where they have remote employees. However, they do not have to foreign qualify even if they meet a state’s nexus criteria. Sole proprietors and general partnerships are considered individuals, not legal business entities. No foreign qualification requirements exist to expand them into other states. While this may seem idyllic in some ways, remember that the owners of sole proprietorships and partnerships bear unlimited liability for their businesses’ legal and financial debts. That lack of personal liability protection becomes amplified by adding more employees and states to the equation.
Remote hiring = opportunities and added complexity
The virtual, cloud-connected world we live and work in has opened opportunities for your business clients. They can attract talent from a broader pool of qualified candidates by expanding their search to other states. However, they should realize these opportunities come with additional payroll considerations — possibly even higher taxes and more business compliance requirements.
Employers must register for payroll in the states where their remote employees work. Depending on the state where your client’s business is domiciled, payroll taxes in a remote employee’s state might be more or less than what they pay in their home state. Moreover, if your business client has nexus in and must foreign qualify their business in the employee’s state, they will bear the cost of the foreign qualification filing fee plus possible business license application fees and other costs.
Needless to say, business owners need accounting professionals’ informed expertise more than ever before as they navigate hiring across state lines. And it’s more critical than ever for accountants, tax advisors and payroll professionals to stay up to date on the evolving employment landscape.