Payroll tax law is set state by state and changes often. The examples below show common patterns and the kinds of differences to expect. Confirm requirements with each state's revenue and workforce agencies before hiring.
A remote hire in another state can quietly turn a one-state payroll into a multi-state one. The employee is happy, the work is fine, and then a state agency asks why you have not registered. The fix is simple if you handle it before the first paycheck, and painful if you handle it after a year.
What changes when an employee works in another state
- State income tax withholding: usually owed to the state where the work is performed, with exceptions.
- State unemployment insurance: generally assigned to one state under uniform tests, not split among states.
- Employer registration: you typically need an account with that state's revenue agency and workforce agency.
- Local taxes: some cities and counties impose their own payroll or income taxes.
- Other items: paid leave programs, disability insurance, new-hire reporting, wage and hour rules, and workers' compensation coverage.
State income tax withholding
The general rule is that wages are taxed by the state where the employee physically performs the work, and the employer withholds for that state. If the employee also lives in a different state, the residence state may tax the same income and give a credit for tax paid to the work state. Some states have no wage income tax at all, including Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming, so an employee working there generally has no state income tax withholding to run. Tennessee and New Hampshire have also eliminated or do not tax wages. Confirm the current rule for any state before assuming.
Reciprocity agreements
Some neighboring states have reciprocity agreements under which a resident of one state who works in the other pays tax only to the home state. In those cases the employee typically files an exemption form with the employer so that the work state does not withhold. Not every pair of states has an agreement, and the details differ, so check the specific pair.
The convenience-of-the-employer rule
A small number of states, including New York, have applied a rule that treats days a nonresident works from home outside the state as in-state days when the home work is for the employee's own convenience rather than the employer's necessity. This can lead to withholding in the employer's state even though the employee works elsewhere. States such as Pennsylvania, Delaware, and Nebraska have comparable rules in some form. The rules are technical, change over time, and are litigated, so get advice if your employer or employee is connected to one of these states.
State unemployment insurance
Unlike income tax, unemployment insurance for a worker is generally assigned to one state using a sequence of tests applied across states: where the work is localized, the base of operations, the place of direction and control, and the employee's residence. For a fully remote employee working from home, the state of the home is often the answer, which means registering for unemployment insurance there. Rates and wage bases differ widely by state. See Form 940 vs Form 941 for how federal unemployment relates to state.
Local taxes
Cities and counties in states such as Ohio, Pennsylvania, Kentucky, Indiana, Maryland, and New York impose local income or payroll taxes that employers must withhold. These are separate registrations with their own rates and filing dates. They are a common blind spot for remote hiring.
Checklist before you hire out of state
- 1Confirm where the employee will actually work, and where they live.
- 2Check the state's income tax withholding rules, reciprocity, and any special sourcing rule.
- 3Register as an employer with the state revenue agency and the workforce agency for unemployment insurance.
- 4Collect the employee's state withholding and any reciprocity exemption forms.
- 5Check for local taxes, paid sick or family leave programs, and state disability insurance.
- 6Make sure workers' compensation insurance covers the new state.
- 7Add the state to your new-hire reporting, payroll software, and compliance calendar.
- 8Consider whether the hire creates income tax, sales tax, or franchise tax nexus for the business in that state.
Mistakes we see
- Withholding only for the company's home state.
- Not registering for unemployment insurance until a state letter arrives.
- Missing local taxes.
- Failing to track employees who move or split time among states.
- Letting an employee work from another state temporarily with no tracking.
Penalties for getting it wrong
States can assess unpaid withholding, interest, and penalties, and employees may owe tax on income that was not withheld. Because withheld tax is held in trust, unpaid amounts can create personal liability for responsible individuals in many states. See payroll tax penalties and small business payroll services. For worker status questions, see W-2 vs 1099 classification.
Our payroll service sets up multi-state payroll registrations, withholding, and filings. To talk about your payroll requirements, tell us the states where your employees work and live.
