Finances and Taxes

How to Pay Employees Who Live and Work in Different States

Leslie Harding Former Customer Experience Writer, Gusto 
Payroll Tips for Out-of-State Employees | How to Pay Employees in Different States

As your team grows, you may find yourself hiring employees from all corners of the country.

No big deal, right?

Everything looks squeaky clean until payroll taxes come into the picture.

Employees in multiple states can cause multiple headaches because each state has a completely different set of rules that govern this stuff. In this article, we’ll explain what to do with a team that works, travels, and lives from sea to shining sea.

First, the golden rule: You generally pay taxes in the state(s) where your employees work.

The twist is that state laws are, quite literally, all over the map. Therefore, it’s important for you to read up on the state legislation that applies to your team.

If you live and work in different states, here are the terms to know

  • Nonresident state: This is any state that you commute to for work or work in for a short amount of time, but it’s not your permanent home.
  • Resident state: On the other hand, this is your permanent home. Think back to the return address label on your holiday cards. Most likely the address is located smack dab in your resident state.

Now, ask yourself these questions

  1. Where does your employee work? Do they work from home or do they travel to work someplace else? If the answer isn’t obvious, do some sleuthing.
  2. If the state they live in is different than where your company is located, is there a reciprocal agreement between the two states? If not, has your employee requested courtesy withholding?

In most cases, you have a withholding responsibility in the state where your employee actually works, which can either be their resident or nonresident state.

So if your company is based in Michigan, but your employee works from home in Georgia, you would withhold income tax and pay state unemployment tax in Georgia only.

What’s the deal with reciprocal agreements?

Here’s where things get tricky. Depending on where your employee lives, they may be able to withhold their income tax in their home state. This allows them to file one tax return each year, which helps simplify things.

All those state friendships happen through something called a reciprocal agreement. The agreement is formed when neighboring states rally together and agree that people who work in nearby states can pay income tax to the state they live in.

Example: Since Illinois has a reciprocal agreement in place, a person can work in Illinois, but pay income tax in their home state if they live in Kentucky, Michigan, Wisconsin, or Iowa.

If there’s no reciprocal agreement between your employee’s home and work state, it’s not the end of the world. Your employee will most likely have to pay both nonresident and resident state income tax. But luckily, most states grant a tax credit to cover the pesky cost of being taxed twice.

Pro tip: You can help those who have to pay income tax in states without reciprocity by offering a courtesy withholding from their paycheck. It’s when employers withhold both sets of state income taxes so employees don’t have to deal with a cash crunch during tax season.

How do I set up reciprocal withholding?

Your employee will need to complete a non-residency certificate to excuse them from tax withholding in their work state. Once they’re done, they’ll send it your way for safekeeping. You won’t have to mail it in, but be sure to lock it up somewhere safe.

When you receive the certificate, let your payroll provider know that your employee has an agreement in place, so they’ll withhold the correct amount in their home state.

Looking for a certificate? Here’s a template you can use.

Common scenarios

To paint a better picture of this whole multi-state employee business, below are a few situations you may find yourself in — and how to deal with them:

1. Your employee resides in Dallas, but works in Oklahoma City.

Although your employee lives all alone in the Lone Star state, you will have to pay taxes for them in the Sooner State.

2. Your employee works from home at their ranch in Wyoming, but your company is located in bustling Manhattan

You will have to pay all of their state taxes to Wyoming, because that’s where the work is actually being completed.

3. Your employee lives in Maryland, but they commute every day to your office in DC

Maryland and DC have a reciprocal agreement in place, so your employee could request that you withhold their income taxes in Maryland, leaving you with only DC unemployment to pay on their behalf.

4. Your employee is working in Pennsylvania temporarily for three months

For nine months, you pay taxes in the state where this person primarily works, and for three months, you pay taxes in the Keystone State.

When you begin to unwrinkle the map of payroll laws, dealing with multi-state employees isn’t so hard. Yes, it’s slightly more intricate, but once you understand the basics, you’ll feel much more in control.

And on tax day, your team will thank you—wherever in the world they may be.

Updated: August 26, 2019

Leslie Harding
Leslie Harding Leslie Harding is a former customer experience writer who helped small businesses get a better handle on payroll, taxes, and everything in between.

Comments

  • Jackie

    Hello Leslie,

    Thanks for the blog. I have a question about your #2 from the list. Does New York state not have the telecommuter rule to tax out of state employee based on the convenience vs necessity rule? Should the employer not withhold NY tax?

    Reply
    • Gusto Editors

      Hi Jackie—since laws vary state by state, we recommend talking to an attorney or CPA about this!

      Reply
  • Sabir Syed

    What about if an employee works in DC (and has an apartment in DC), but their permanent address is in Pennsylvania (on their Driver’s License). What state would taxes be withheld for?

    Reply
    • Gusto Editors

      Hi Sabir! State laws on taxes can vary, so we recommend taking a look at the different legislations and/or talking to a CPA!

      Reply
  • Frank

    I have a company based in Indiana. One new hire will reside in Illinois and work-from-home in Illinois 3 days a week, and travel to Indiana and work on-site in Indiana 2 days a week. Do I need to withhold both Illinois and Indiana state and county taxes? I do the payroll myself – 12 employees total, all work and reside in Indiana except the 1 new hire.

    Reply
    • Gusto Editors

      Hi Frank! We recommend talking to an attorney or CPA about this, as they’ll be able to give you advice specific to your situation.

      Reply
  • Ellen

    I Live and work in Texas, no state taxes..
    The company I work for is located out of Illinois, they are taxing me state income tax.
    Is this correct?

    Reply
    • Gusto Editors

      Hi Ellen, we recommend speaking to your attorney, as they’ll be able to give you answers for your specific situation.

      Reply
  • Krista

    What if my employer is in CA, I’m moving from FL to Indiana but living temporarily in Kentucky?

    Reply
    • Gusto Editors

      Hello, Krista! Please reach out to your attorney, since they’ll be able to provide you with legal advice for your specific situation.

      Reply
  • Jennifer

    If my employee’s permanent residence is in GA and they are working in WY, since WY doesn’t have income tax, do I withhold taxes for my employee in GA?

    Reply
    • Gusto Editors

      Hello, Jennifer! Please reach out to your attorney, as they’ll be able to provide legal advice for your specific situation.

      Reply

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