How to Determine State Income Tax Withholding for Nonresident Employees
Author: Alice Gilman
In general, an employer must withhold income taxes from the pay of an employee for the state in which the employee works. Therefore, employees who work in a state they do not live in are usually subject to withholding for the work state's income tax in addition to the income tax of their state of residence.
On the other hand, an employee who works entirely remotely (e.g., from their home) for an employer located in another state is usually subject to income tax withholding only for their state of residence. There are some situations, however, in which an employer must withhold income taxes for a remote nonresident employee's state of residence and the state in which the employer's office is located.
Employers must consider several factors to correctly determine nonresident withholding in each of these scenarios.
One key factor is whether the employer has established nexus (i.e., a substantial business presence or link) with the state (and possibly the municipality) in which a nonresident employee lives and works. Once nexus has been established with a state, the employer must withhold that state's income taxes, and possibly also that state's unemployment and disability insurance taxes since liability for those taxes is tied to an employee's work state.
Other important factors include whether any income tax exemptions apply to a nonresident employee, whether an income tax reciprocity agreement exists between the relevant states and whether the employer will offer courtesy withholding to a nonresident employee.
Correct withholding is essential. An employer that fails to properly withhold income taxes from the pay of employees, or to report and remit the withholdings to taxing agencies as required, will be subject to costly noncompliance penalties and fines. Such failures may in turn open the door to an audit of the employer's activities regarding other types of taxes (e.g., nonpayroll business taxes such as sales, use, franchise and other corporate taxes) and other wage and hour practices. Even if an employer manages to sidestep these consequences, the hassle and time involved in having to make payroll tax corrections is something to be avoided.
This How To helps an employer determine which states' income tax to withhold from the pay of:
- Nonresident employees who go into their employer's state to work; and
- Nonresident employees who work for their employer remotely (e.g., from home).
Note: Step 1 through Step 4 apply to nonresident employees who go into their employer's state to work. Step 5 through Step 7 apply to nonresident employees who work remotely. Step 8 through Step 10 apply to both types of nonresidents.