Telework was a growing practice before the pandemic. With stay-at-home orders, the number of employees working remotely skyrocketed. Even as these orders have lifted, many employees continue to work from home. A study from Mercer reported this summer in U.S. News expects more than half of all employees to continue remote work after the pandemic. What happens if an employee’s home is in a state that’s not the same as where the employer is located? This presents payroll tax issues. Each state has its own rules for income tax withholding (other than in Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming where there is no income tax). Here are some matters to keep in mind.
Basic federal payroll tax rules
For federal payroll tax purposes, the location of the employer and employee are irrelevant. Federal income tax withholding applies regardless of their location. Similarly FUTA tax applies. The determination of a “credit reduction state” for FUTA tax purposes, which impacts the amount of federal unemployment tax paid by the employer, is based on the employer’s location. Credit reduction states are listed in Schedule A of Form 940 (the 2020 draft does not yet include which states are designated as credit reduction states).
Multiple states involved
For state payroll tax purposes, things get complicated when the employer and employee are in different states. Where should an employer withhold state income taxes?
Living and working in a different state. Usually, an employer must withhold income tax in the state where the work is performed. But if an employee who resides in another state works exclusively in that state which is different from the employer’s state, then taxes are usually withheld only in the employee’s state. For example, an employer is in State X but the employee lives and works exclusively in State Y. The employer should withhold income tax for State Y, assuming it has an income tax. However, there are exceptions to this rule.
Living in the employer’s state but working in a different state. If an employee lives in the same state where the employer is located, income tax withholding must be withheld for that state even though the employee works exclusively in another state. Connecticut, Delaware, Nebraska, New York, New Jersey, and Pennsylvania have a “convenience of the employer” rule. This rule says that if the employer requires the employee to work in another state (it’s for the employer’s convenience), then withholding is only taken in the location where the work is performed. If, however, the employee chooses to work in another location (it’s for the employee’s convenience), then withholding must usually be made in both locations (the employee may escape double tax via a state income tax credit).
As mentioned earlier, the pandemic has led to significant number of employees working from home and that home may be in a different state from the employer’s location. Some states have made special income tax withholding rules to address this “temporary” situation (at least through the end of 2020). For example, employees temporarily working in Alabama and Georgia due to COVID-19 are not subject to income tax withholding in those states.
Some states have different requirements. In New York, “[i]f you are a nonresident whose primary office is in New York State, your days telecommuting during the pandemic are considered days worked in the state unless your employer has established a bona fide employer office at your telecommuting location.” Massachusetts has a similar rule (at least through the end of this year). Check the rules in your location; they may be different.
Payroll is a complicated issue for many companies. It is always a good idea to rely on experts, such as CPAs or payroll companies, to ensure that you get things right.