How to Manage Multi State Payroll Taxes

Multi-state payroll taxes are the legal requirement for a business to withhold and pay payroll taxes in every state where it has an employee. With the significant increase in remote and hybrid work, businesses of all sizes now find themselves hiring talent from various states, creating new tax responsibilities. This expansion of the workforce across state lines introduces a complex web of differing tax laws, rates, and regulations. An employer in one state with a single remote employee in another may suddenly be subject to a new set of rules, making it necessary to understand these obligations to maintain compliance, avoid potential penalties, and ensure employees are taxed correctly.

Determining Your Tax Obligation

A company’s requirement to engage with another state’s tax system is based on the concept of “nexus.” Nexus is a connecting link or presence between a business and a state that is substantial enough to create a tax obligation. For payroll, this is often called income tax nexus, and it is the trigger that requires a business to begin withholding and paying taxes in that jurisdiction. Once nexus is established, the business must comply with that state’s specific payroll tax laws.

The most common trigger for establishing payroll tax nexus is having an employee physically present and working in a state. A single employee working consistently from their home can be sufficient to create nexus, even if the company has no office or other physical operations in that state. This means hiring a remote worker or allowing an employee to relocate establishes this connection and the associated tax duties.

Nexus can also be created by employees who travel for work. Salespeople or consultants who spend time performing services in other states can establish a tax presence for their employer. Some states have thresholds, such as requiring withholding after an employee works in the state for a certain number of days, while others may require it from the first day.

The presence of a company-owned or leased office, warehouse, or retail store also firmly establishes a physical presence and, therefore, nexus. This traditional trigger is more straightforward but operates on the same principle. The state where the work is physically performed is what dictates the tax obligation, not where the company’s headquarters is located.

Identifying Applicable State and Local Taxes

Once a tax obligation exists in a new state, the next step is to identify the specific types of payroll taxes that must be paid. These taxes vary significantly from one state to another in terms of rates, rules, and which party is responsible for payment. The most common types are:

• State Income Tax (SIT): This is withheld from an employee’s wages based on where they perform their work. Nearly all states with an income tax require this withholding, though a handful of states, such as Florida and Texas, do not have a state income tax.
• State Unemployment Tax Act (SUTA): This is an employer-paid tax that funds state unemployment benefits. When a business registers in a new state, it is assigned a “new employer” SUTA rate, which can change over time based on the company’s experience rating, influenced by the number of former employees who have filed for unemployment benefits.
• Local Payroll Taxes: In some states, cities, counties, school districts, or other municipalities are empowered to levy their own income or wage taxes. A business might need to withhold taxes for the state, the county, and the city for a single employee. States like Pennsylvania and Ohio are known for having a large number of local tax jurisdictions that employers must navigate.
• Other Mandatory Deductions: Some states mandate payroll deductions for specific social insurance programs, such as state-run disability insurance funds or paid family leave programs. For example, California requires employers to withhold for State Disability Insurance (SDI) from employee wages.

Establishing Payroll in a New State

Setting up payroll in a new state involves registering with the correct state agencies and gathering specific information. Before beginning, a business should have its Federal Employer Identification Number (FEIN) readily available. Other necessary details include the legal business name, physical and mailing addresses, corporate structure, and the date the first employee began working in that state.

The first step is to register for an income tax withholding account, which is typically managed by the state’s Department of Revenue. This process is almost always completed online through the agency’s portal. The application will require the business’s FEIN and other identifying information to establish an account, after which the state will issue a unique withholding account number.

Separately, a business must register for a State Unemployment Tax (SUTA) account. This is often handled by a different state agency, such as the Department of Labor. This application is also usually found online and requires detailed business information. Upon registration, the state will issue a SUTA account number and assign the company its initial unemployment tax rate.

It is important to complete these registrations as soon as the obligation is triggered, as failing to register in a timely manner can lead to penalties. The goal is to obtain the necessary account numbers to legally withhold taxes, make payments, and file returns in the new state.

Managing Ongoing Compliance and Reporting

After registering in a new state, the focus shifts to the recurring tasks required to maintain compliance. This begins with accurately calculating and withholding the correct state and local income taxes from each employee’s paycheck, guided by state-specific withholding allowance certificates. The withheld income taxes, along with the employer’s SUTA contributions, must then be remitted to the appropriate state agencies according to a prescribed deposit schedule, which could be monthly or quarterly.

In addition to making regular tax deposits, businesses are required to file periodic payroll tax returns. These returns, usually filed quarterly, reconcile the total tax liability for the period with the deposits that were made. Separate returns are typically required for income tax withholding and unemployment insurance and must be filed with their respective state agencies to avoid penalties.

A specific compliance action involves managing state tax reciprocity agreements. These are pacts between states that allow an employee who lives in one state but works in another to only pay income tax to their state of residence. If an employee provides a valid exemption certificate, the employer must adjust withholding to the employee’s home state instead of the work state.

The compliance cycle culminates in year-end reporting. Employers must prepare and file annual reconciliation forms with each state where they withhold taxes, summarizing the total wages paid and taxes withheld. They must also provide each employee with a Form W-2, ensuring the state-specific boxes are filled out correctly for each state in which the employee worked.