Expanding your business means hiring remote workers from various states, which introduces complexities when it comes to paying them. Each state has its own unique set of payroll regulations, making it challenging to navigate payroll responsibilities.
However, by understanding how to pay remote workers, you can overcome these challenges and build your ideal team, no matter where they are located.
When it comes to employees who work from home in a different state, the general rule is to pay state withholding taxes in the state(s) where they work. However, it's important to note that state laws can vary significantly. Therefore, it is crucial to familiarize yourself with the specific legislation for employees working in different states. Alternatively, you can simplify the process by choosing a payroll provider that handles payroll taxes for out-of-state employees.
There are two distinct categories of workers that can be hired for your business: employees and independent contractors.
It's important to note that the classification of a worker as an employee or contractor is determined by federal and state laws, not solely by your preference. Misclassifying an employee as a contractor can have serious consequences, including potential tax penalties.
Staying informed about state laws is crucial since they are subject to change. For example, California's Assembly Bill 5(AB5) implemented stricter guidelines for worker classification, making it more challenging for small businesses to classify workers as contractors since January 1, 2020.
Knowing whether your worker is an employee or contractor is essential because it affects how you pay them, especially for remote work. Understanding the distinction allows you to comply with the appropriate payment and tax requirements based on their classification.
To properly pay a remote employee, you must determine whether they are an in-state or out-of-state remote employee. Understanding the following terms is helpful:
Once you have this information, consider the following questions:
In most cases, you are required to withhold taxes in the state where your employee actually works, whether it's their resident or nonresident state. For instance, 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.
When remote employees work in the same state where your company is registered, you will need to withhold state income taxes from their paychecks and pay state unemployment insurance (SUI) tax in your home state.
Additionally, if your employee works in a location that requires local income tax, you may also need to withhold and remit that tax accordingly.
However, if your employee works in your state but resides in another state, you would still withhold state income taxes in your state since that's where the work is being performed. This is true unless your state has a reciprocal agreement with your employee's home state. Reciprocal agreements allow employees to pay income tax to their home state even if they work in a different state.
1. Reciprocal Agreements
Reciprocal agreements usually state that:
If an employee lives in California but commutes to a work location in Arizona, employers should withhold income tax in California (per the reciprocal agreement between the states). Another example of a state with a reciprocal agreement is Illinois, where individuals can work in Illinois but pay income tax in their home state if they reside in Kentucky, Michigan, Wisconsin, or Iowa. If reciprocity exists between the two states, employees will need to complete and deliver a non-residency certificate to you in order to have the residency state tax withheld instead of the work state tax.
However, if there is no reciprocal agreement between your employee's home state and the state where they work, it doesn't necessarily create an insurmountable problem. In such cases, your employee will likely be responsible for paying both nonresident and resident state income taxes. Fortunately, some states provide a tax credit to alleviate the burden of double taxation. This credit helps offset the additional tax liability incurred due to earning income in a nonresident state while also being liable for taxes in their home state.
2. How To Set Up Reciprocal Withholding
To exempt your employee from tax withholding in their work state, they will need to complete a non-residency certificate. Once they have filled out the certificate, they should send it to you for safekeeping. You don't need to mail it in, but it's essential to store it securely.
Upon receiving the non-residency certificate, inform your payroll provider about the agreement in place. This ensures that the correct amount is withheld in your employee's home state. Remember, maintaining accurate and organized records of these certificates is crucial for compliance and record-keeping purposes.
If your employee works from home in another state, there are three important steps to follow.
1. Register With Your Employee's State Tax Agency
Since you will be withholding income taxes in your employee's home state, it is necessary to register with the state tax agency and possibly local tax agencies. You might also need to register with their state's labor and unemployment agencies. If you have multiple remote employees working in different states, you will need to register with the tax agency in each state.
2. Learn The State’s Pay And Labor Laws
In addition to withholding state income taxes, it is crucial to familiarize yourself with and adhere to your employee's state pay and labor laws when they work from home in another state. Here are key considerations for each employee in such situations:
By staying informed and adhering to these considerations, you can ensure compliance with the pay and labor laws of each state where your remote employees work from home.
3. Withhold Income Taxes And File Required Paperwork And Payments
Every time you compensate your employee, it is necessary to withhold state income taxes from their earnings. Subsequently, you will need to complete and submit paperwork to the state periodically, disclosing the amount of income tax withheld, and make the corresponding payment. The specific forms to be filled out and the frequency of filing paperwork and submitting payments will vary depending on the state.
Additionally, you are responsible for paying state unemployment taxes based on your employee's wages. When you register with the state's tax or unemployment agency, you should receive information about your unemployment tax rate and instructions for making payments. To simplify these income tax withholding and filing requirements, some payroll providers, such as Gusto, offer services to handle these tasks on your behalf, alleviating the administrative burden of your responsibilities.
Paying a remote contractor is generally less complex than paying a remote employee because you typically don't have to handle state payroll taxes. However, it's important to note that if your contractor commutes to a non-resident state for work, you might need to collect backup withholding taxes as per the state rules. Make sure to check your state regulations regarding backup withholding for nonresident contractors and confirm if your payroll provider supports this requirement.
Although you generally don't withhold state payroll taxes for remote contractors, there are still some paperwork obligations involved:
1. Form 1099-MISC
Each year, you need to file a 1099 form for every contractor you paid more than $600. This form informs the government about the amount you paid to an individual as non-employee compensation during the year. The deadline for submitting 1099s is January 31st. You send one copy to the IRS and another copy to the contractor. Some payroll providers can assist you with this process.
2. Form W-9
Before making payments to a remote contractor, it's necessary to obtain a completed W-9 form from them. The W-9 form, titled "Request for Taxpayer Identification Number and Certification," provides you with the required information to complete a 1099 form. It also helps determine if the contractor is exempt from receiving a 1099. If the contractor fails to provide a W-9 form with the correct taxpayer identification number (TIN), you might be obligated to collect backup withholding taxes for them.
While paying a remote contractor is generally straightforward (paying the owed amount), it's crucial to maintain accurate records of your payments. These records will be used when filing your 1099 forms.
Gusto Payroll is a user-friendly payroll software designed to simplify and automate the payroll process for small to medium-sized businesses. Its features include an intuitive interface, automated payroll scheduling, tax compliance, employee self-service, and benefits management. Business owners can benefit from time savings, improved accuracy, enhanced security, streamlined onboarding, and comprehensive reporting. Gusto Payroll helps businesses save time, reduce errors, and stay compliant with tax regulations, allowing them to focus on other essential aspects of their operations.
In conclusion, understanding the distinction between tax resident and non-resident employees and contractors is essential when paying remote workers. Compliance with state tax laws is crucial, as misclassification can result in penalties. Staying updated and consulting with a tax professional is always advised to ensure accurate guidance and compliance with regulations.
Disclaimer: This information is not tax advice. Consult a CPA or tax advisor for specific guidance due to changing tax rules that vary by location and industry.
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