The Impact of Remote Work and Multistate Employment on Employment Tax

Introduction

The rise of remote work has significantly reshaped the modern workplace, offering employees greater flexibility while presenting new challenges for employers. At the same time, regular business travel to client or other business destinations are picking up once again, as employees begin to spend more time traveling outside of their home location.  Both remote work and regular business travel result in significant complexity in the requirements for multistate taxation, which affects both businesses and employees who work across state lines. This article explores the impact of remote work and business travel on productivity, work-life balance, and taxation, providing employers with essential insights for compliance.

The Evolution of Remote Work

Remote work has transitioned from a niche arrangement to a mainstream practice, driven by technological advancements and changing workforce expectations. While some employers believe that remote work can boost productivity, reduce overhead costs for businesses, and improve employee satisfaction, the challenges to an organization from a payroll tax perspective can be significant.  Most notably, understanding the state and local employment tax rules and regulations with respect to how, when and where to impose payroll taxes can be significant.  Coordination of Human Resource, Finance, Benefits and Payroll departments is essential in insuring that employees are taxed appropriately and that employers are following the proper path to compliance.

Rediscovering Business Travel

While some employers embrace work-from-home, others want their employees in the field, meeting with clients and visiting their internal colleagues.  Business travel is nothing new of course, both from a U.S. and an international perspective.  What is somewhat new is the push to multistate withholding of state and local income tax compliance across state lines, and the intricacies involved with such compliance.

Multistate Taxation and Employer Responsibilities

With employees working remotely from various locations and traveling extensively, businesses must address multistate income tax withholding requirements. Each state has unique tax laws that determine whether an employer must withhold taxes based on the employee’s location or residency status. 

Key Considerations for Employers

1. Withholding Tax Obligations

Employers must generally withhold state income taxes with respect to employees based on where work is performed and/or the employee’s residency. However, different states enforce varying requirements:

• Physical Presence Rule: Most states with an income tax require withholding if an employee physically works in that state and is paid wages or other compensation based upon the time spent working in that jurisdiction.  This requirement can be balanced (i.e. coordinated so as not to result in double taxation) by either reciprocity agreements with other jurisdictions or, for mobile employees, de minimis requirements for short-term or limited visits to a nonresident state.
• Convenience of the Employer (COE) Rule: States like New York and Pennsylvania impose tax obligations based on where an employee’s work is intended to be performed, even if they work remotely from another state.  This can be extremely complex to both understand and implement from an employer perspective.  In addition, the impact on an employee can be profound in the event a state taxing agency pursues a position of COE.
• No Withholding States: Nine states do not have income tax withholding provisions (and the District of Columbia has withholding required only for D.C. residents).  Employers do not have to withhold on any income earned by employees either resident or for the wages sourced to services in those state.  It is important to note that simply residing in the state does not exempt an employee from taxation in other states where they may provide services.  For example, a Florida (non-income tax state) resident who performs some of their services in New York, is generally subject to New York state income tax on the earnings that are New York sourced.  The employer should withhold from those wages, taking into account any de minimis exceptions.

2. Reciprocal Agreements

Some states have agreements allowing employees to pay tax only to their state of residence, avoiding double taxation. Examples include:

• New Jersey and Pennsylvania: Employers with employees working across these states may only be required to report and remit taxes to the employees’ state of residence.
• Illinois and Iowa, Kentucky, Michigan, and Wisconsin: Similar agreements exist to simplify tax withholding.

In order to properly implement and maintain the advantages of the reciprocity agreements, employers must require employees to complete reciprocity exemption forms, such as Pennsylvania’s REV-419 or Illinois’s IL-W-5-NR, to claim these benefits.  In the event of a state audit or review, if exemption certificates are not signed and retained by the employer, the work-in state could impose nonresident withholding and assess penalties and interest for failure to properly address in-state taxation.

3. Employer State Withholding Registration

In many cases of multistate/nonresident employment, a business with an employee performing services in a state must register with each state where they are required to withhold tax. The registration process and adjacent requirement can be time consuming and is very fact specific.  Some states require online registration of new businesses, while some still permit paper applications.  In addition, some jurisdictions have consolidated registrations (e.g., inclusive of income tax withholding, sales tax, unemployment, etc.) while others have separate registration requirements for each tax type. 

One of the trickier areas of nonresident withholding is with respect to timing.  Most states do not allow employers to register in advance for accounts but instead require the registration to be submitted on or about the first day of work or wages paid in the state to an employee.  This becomes somewhat problematic when tax deposits are due soon after the initial work start date, but an account has not yet been established. In these cases, online registration is typically the quickest solution, with some providing account numbers immediately upon registration.

4. Nonresident Tax Withholding Requirements

Employers are responsible for withholding state income tax when an employee performs work in a nonresident state unless a specific exemption or the above noted reciprocity applies. Some states, like California, Pennsylvania, and Massachusetts, have strict withholding thresholds, requiring tax withholding if an employee works there for as little as one day.  Other states, like New York and Connecticut, provide a de minimis exception before employer withholding of tax applies.

In order to fully comply, employers would need to implement specific tracking processes for employee travel.  Because of this, many employers implement policies that are practical to their business and minimally impact their employees in terms of tax impact and administrative burden. One of the easiest ways to control both the tax and administrative burdens is to effectively implement applicable de minimis provisions. 

• De minimis exemptions: Some states have grace periods for withholding which should not be confused with a tax-free period for the employee. The de minimis exemption generally applies when a nonresident performs services in a state and the individual is not expected to be a long-term employee in that jurisdiction.  It is also important to note that in some states, like New York, the de minimis exception is for employer withholding, but it does not exempt the individual from a tax liability for this period.  For example:
  • A business has an employee who will periodically be providing services in New York.  It is not anticipated that the individual will spend significant time in the state during the calendar year.
  • New York has a de minimis for withholding on services performed in the state of 14 days (subject to withholding on day 15). 
  • The employer must begin withholding New York State income tax the earlier of 1) day 15 of services performed in the state, or 2) when the company realizes the individual will be working in the state in excess of 15 days for the calendar year.
  • The individual may have a personal income tax liability for the days worked in New York state prior to the start of withholding.

Below is a table inclusive of states with current de minimis exceptions.

5. Local Tax Compliance

Beyond state taxes, some municipalities and local governments impose local income taxes that require employer withholding. In some cases, the locality taxes are included with state taxes for reporting purposes (e.g. New York City is reported with New York State) but many have separate reporting and remittance process for different localities.  Some examples of locality taxation include:

• New York City: Employers must withhold the New York City Personal Income Tax (NYC PIT) if an employee lives in NYC, even if they work remotely.  However, nonresidents performing services in NYC are not subject to NYC PIT.
• States such as Ohio, Pennsylvania and Kentucky have a large number of local income tax jurisdictions that employers must navigate, often based on resident, nonresident or work location parameters.  In many cases reciprocity exists between resident/work locations to avoid double taxation.  In addition, many jurisdictions, such as Philadelphia, have different tax rates for city residents vs. nonresidents.

Many state websites provide online locality tax identifiers allowing employers to input an employee resident to determine the proper state of withholding and reporting.

6. State Unemployment Insurance (UI) Registration and Compliance: If an employer has employees performing services in a state, they may be required to register for SUI taxes.  The rules and requirements governing SUI taxation and reporting are based on a four prong test applicable to each employee, taking into account 1) where primary services are performed 2) what the employee’s base of operations is 3) where the employee takes their direction and control, and 4) where the employee resides. 

7. Other State Employment Considerations: In addition to state and local withholding and SUI taxes, many states have other requirements for employees and employers performing services in a jurisdiction.  Programs such as Disability Insurance (DI), Family and Medical Leave Insurance (FMLI), Paid Family and Medical Leave (PFML) and related programs are mandatory in most states and will generally follow the SUI requirements in terms of reporting and remitting. 

Compliance and Leading Practices

Remote, multistate and nonresident withholding can be one of the most complicated and vexing tax issues for an employer to contend with.  Traditional payroll and HR systems are not always designed to withhold taxes in multiple jurisdictions, and most employers do not have in place a “tracking” system to allow for an accurate understanding of where employees are working on a daily basis so as to ensure such compliance.   In prior years, most states and local tax jurisdictions did not aggressively pursue employer withholding of nonresidents or even remote employees, but the change in the overall workplace has created regimes that are much more invested in securing such amounts.  While employers often have a difficult time coming into compliance in the space, it may be important to your business to consider steps to begin a process for future compliance. Consider the following:

1. Monitor Employee Locations

• Depending upon the level of compliance a business intends to reach, employers may utilize geolocation tools or require employees to submit regular location declarations to determine where they are working.  Many employers that utilize hours to charge clients for services provided have begun layering in the location of work with that requirement so as to not overly burden employees but to still gather that information.

2. Understand State-Specific Laws

• Consult with a tax professional or use multistate payroll software to track each state’s rules.
• Review each state’s “threshold days” for nonresident tax obligations.

3. Implement Clear Remote Work Policies

• Draft an employee remote work agreement outlining tax implications.
• Provide employees with guidance on tax withholding forms, including state reciprocity agreements and residency declarations.
• Analyze state/local income tax and state unemployment insurance requirements in every jurisdiction where you have remote employees.

4. Register and File Taxes Properly

• Ensure timely state withholding tax registrations for employees working in multiple states.
• Use payroll software or services that automatically update tax compliance based on employee location.

5. Review Remote Work Tax Implications Regularly

• Stay updated on state law changes and update withholding policies accordingly.
• Regularly audit payroll tax records to avoid compliance risks.

Conclusion

Remote work offers undeniable benefits but introduces complexities in tax compliance. Employers must stay informed about multistate taxation laws to mitigate risks and ensure proper tax withholding. By implementing proactive tax strategies, businesses can embrace remote work while maintaining compliance with state and local tax regulations.