If you have remote employees in states other than where your organization is located, understanding the tax rules can be challenging.
While remote work has been a phenomenon for decades, the COVID-19 pandemic and technological advancements have made remote work an increasingly common practice for working Americans.
According to McKinsey’s1 2022 American Opportunity Survey, 58% of employees work from home at least once a week, while 35% work remotely full-time. As of 2023, these numbers may decrease as many employers issue return to office plans. However, it’s highly unlikely that remote work will disappear completely.
With so many people working from home, employers and state governments face new challenges regarding taxation, nexus, and employee benefits. Each state has its own approach to taxation, and depending on where you live and work, this tax obligation varies.
This article explains how taxes work for remote employees, including the different types of remote workers, which states have unique tax circumstances, and how remote work affects employee benefits.
How are employees taxed when working remotely?
In a traditional, in-person work environment where your employees live and work in the same state as your organization, there is less uncertainty to navigate. You simply withhold state income taxes, if applicable in your area, and pay any required payroll taxes.
If employees work remotely in your same state, these rules also apply, usually with only a few changes to local taxes.
However, when employees work remotely from another state, things can get complicated. Generally, your employees are taxed by the state where they live and work. You should speak with the labor and unemployment agencies of each state your employees live and work in to ensure that you follow all the proper tax procedures and withholdings.
For example, if your employee works for your Utah-based organization but they live and work from home in Oregon, you must withhold all state and local income taxes for Oregon from their pay and benefits. You will also have to pay any required unemployment taxes and special taxes for that location.
There are exceptions to this scenario. We’ll cover a few of them in the section below.
How taxation works for different types of remote workers
Remote work doesn’t just mean working from home. There are many different types of remote workers, and they each have different circumstances that can affect taxation.
Employees who commute across state lines
Organizations near state borders often hire employees from other states who commute to work across state lines. This is common in cities such as Portland, Chicago, El Paso, Washington D.C., and New York City.
Unlike other remote workers, these commuter employees live in another state but work in the same state as your organization. This creates some unique income tax circumstances.
In this case, you and your employee could be subject to tax liabilities in both states. Reciprocal agreements—or a compromise between states that allows nonresident workers to request tax exemption from the other state—exist in some places to prevent double taxation, but only some states have one. In these situations, the employee's resident state may issue a tax credit for any income paid to your organization's state.
For example, according to the state of Maryland2, residents of the state who work in Washington, D.C., Pennsylvania, Virginia, or West Virginia only file their state income taxes for Maryland, thanks to a reciprocity agreement with those places.
Another consideration is unemployment withholdings. In this case, you usually pay unemployment tax to the employee's state of residence.
Employees who live out of state and work from home
If you have a telecommuting employee in a different state than your location or employees in multiple states, you must withhold income taxes for the state they live and work in. You'll pay unemployment taxes and report their income to the states where they live, not your state.
However, some states use “convenience of employer” rules that require you to pay taxes in your state, not the employee's state. Additionally, double taxation risks, such as those for employees who commute across state lines, can still exist in some states.
For independent contractors, taxes are different. As 1099 contractors aren't employees, they must pay their taxes as an independent business to their state of residence (if working remotely).
If you have employees who recently moved to a new state and worked remotely, they'll need to establish a new domicile, or permanent residence, to avoid being taxed in their current and former states. Many states will audit former residents to determine if they are no longer a resident. The more evidence your employees have that they live in their new state, the harder it is for their previous state to claim them as a resident for tax purposes.
Some steps your employees can take to establish domicile are:
- Update their mailing address for all bills
- Obtain a driver's license in their new state
- Register to vote
- Close any bank accounts in their old state
- Buy or rent a home in their new state
Employees who are temporarily working out of state
So far, we've discussed permanent employees and contractors who are permanent residents of their respective states. What happens if you have employees who are temporarily working remotely?
Suppose your temporarily remote employee typically works in the same state or location as your organization but is currently working remotely in another state. It’s expected that temporary remote workers will return to their permanent location. Otherwise, they’re considered a permanent resident of the other state.
Each state has its own rules regarding how long an employee can work in that state as a nonresident or part-year resident without owing income tax. In some cases, though, an employee may need to file non-resident tax returns.
Convenience rule states
Some states have a convenience of employer test or convenience rule. This test requires that you withhold and pay taxes to the state where your organization is located, even if your employees live out of state, if they do so out of convenience. Unless you specifically require your out-of-state workers to be remote in their state, you have to withhold taxes for your state.
The states with convenience of the employer rules are:
- New York
That means if your organization is based in New York, but you have an employee working from home in Utah, you have to withhold New York taxes.
How does remote work affect sales taxes and nexus?
In many states, having an employee or any official presence in that location triggers sales tax nexus for your organization. This is further complicated by local tax jurisdictions, such as counties and cities.
Suppose you become liable for collecting and remitting sales tax for states due to remote work. In that case, you'll need to register for a sales tax permit and file sales tax returns to that state on the schedule that applies to your business (usually based on the number or value of transactions).
How does remote work affect taxable employee benefits?
If you offer taxable employee benefits such as employee stipends, you'll also need to report the additional taxable income to the states that require it. This is because taxable benefits are considered additional income and must be reported on an employee's Form W-2. This affects the total amount of taxable wages and withholdings for your employees' individual income tax.
What remote work taxes are employers responsible for?
At the federal level, employers must withhold federal income tax, Social Security taxes, Federal Unemployment Tax (FUTA), and Medicare taxes for all W-2 employees, including remote workers.
There are also state income taxes and state unemployment tax assessment (SUTA) taxes that can differ by location. For example, some states, like Washington, don't have a state income tax for wages. However, Washington has unique employment taxes and mandatory benefits such as paid family, medical, and sick leave. You should check with each state you have employees in to see what taxes you are responsible for.
The states without income taxes are:
There are also local taxes that you may be required to pay or withhold from your employees' paychecks, depending on their state of residence.
Other remote work considerations
In some states, you may also be required to reimburse your employees for their remote work costs, such as the necessary tools to do their jobs.
One way to ensure that you remain compliant in these states while benefiting your entire remote team is to offer a remote work employee stipend. This enables you to give your employees a taxable allowance for their remote work expenses, such as internet access costs, cell phone bills, and home office setup costs.
You’ll also want to draft a company policy for remote work expense reimbursement in accordance with your local laws.
You could be responsible for additional employer withholding and sales tax responsibilities if you have workers in another state who don’t work in a company office. However, this differs based on the states where your employees live and where your organization is located.
Allowing your employees to work remotely in other states can create challenges for your organization, but it also boosts productivity, employee retention, and employee morale and helps create a more inclusive company culture that can create more benefits for you in the long run.
Be sure to consult with a tax adviser to ensure you comply with all applicable laws for your organization.
If you're new to offering benefits to employees across state lines, we can help! Connect with a personalized benefits advisor for a one-on-one chat to see which benefits work best for your organization
This blog article was originally published on July 6, 2022. It was last updated on January 26, 2023.