Understanding Multistate Payroll Tax Compliance


Emptech's founder, Jeff Aleixo


Jeffrey Aleixo

multistate payroll tax compliance

Managing payroll taxes can be complicated, given that they are subject to change due to local, state, and federal regulations. However, multistate payroll tax compliance is even more complex as payroll teams need to navigate different states’ sets of rules for employees who are residents of one state and work in another.

While doing business in multiple states and countries is a sign of growth and expanding business opportunities, it can also add risk and administrative burden. However, in today’s world working remotely becomes a necessity due to the COVID-19 pandemic, requiring employers to take additional considerations when determining taxes.

Meeting multistate payroll tax compliance is considered among the top problems facing payroll professionals, making it even more critical for employers to on top of these requirements, as failing to do so could result in serious consequences.

Key Concepts of Multistate Payroll Tax Compliance

Multistate payroll refers to situations where employees live in one state but work in another state or multiple states throughout the course of the year. As such, multistate payroll tax involves managing sets of state and local laws, regulations, and deadlines, making it difficult to determine employer withholding obligations.

Therefore, to tackle this issue effectively, employers need to understand some of the key concepts of the multistate payroll tax, such as nexus, reciprocity agreements, and nonresident taxation policies. Nowadays, overcoming these regulatory hurdles is a necessity not only for maintaining compliance but also for meeting business demands due to the steady growth of the remote workforce.

Nexus as Important Part of Multistate Payroll Tax Considerations

Nexus refers to a business’s connection between a taxing jurisdiction, such as a state or county. If a business has nexus, it means the business has a tax presence in that jurisdiction. As the required level of connection between a business and a state or locality before taxes may be imposed, nexus is an important but complex multistate payroll tax consideration. Apart from payroll tax, nexus applies to sales tax.

Generally, nexus is established by having a business presence in a state, such as an office, store, or factory. For state income tax withholding, nexus determines whether an employer is required to withhold tax for a given state. The general rule is that tax should be withheld where the employee works. If an employee lives in one state and works in another, the employer is responsible for withholding tax for both states if it has nexus in both of them, but the work state has priority.

Learn what steps to follow when collecting and filing payroll taxes to avoid costly fines and ensure compliance with different state and federal regulations.

Reciprocity Agreements

Reciprocity agreements are an exception to the general rule of withholding tax for the work states and allow the tax to only be withheld for the state of residence instead of the work state. A reciprocity agreement allows employers to withhold only for the state of residence, as opposed to the state in which services are performed. The general purpose of reciprocity is to make things administratively easier for both the employee and the employer. In this case, the employee has to file one state personal income tax return, and the employer has to withhold only for the state in which the employee lives.

Companies should keep track of reciprocity agreements between states to know what taxes are due and to be sure that taxes are not overpaid. A total of seventeen jurisdictions, including the District of Columbia, have at least one reciprocity agreement and employees need to file the following forms for an exemption from withholding:

  1. Arizona –  Form WEC;
  2. District of Columbia – Form D-4A;
  3. Illinois – Form IL-W-5-NR;
  4. Indiana – Form WH-47;
  5. Iowa – Form 44-016;
  6. Kentucky- Form 42A809;
  7. Maryland – Form MW507;
  8. Michigan – Form MI-W4;
  9. Minnesota – Form MWR;
  10. Montana – Form MT-R;
  11. New Jersey – Form NJ-165;
  12. North Dakota – Form NDW-R;
  13. Ohio – Form IT-4NR;
  14. Pennsylvania – Form REV-419;
  15. Virginia – ​Form VA-4;
  16. West Virginia – Form WV/IT-104R;
  17. Wisconsin – Form W-220;

Nonresident Taxation Policies

Together with the factors of whether a company has nexus and determining if the states in which the employee is working and living have reciprocity agreements, the nonresident certificate is another critical aspect of multistate payroll tax compliance.

If an employee is a resident of one state but performs services in another, and there is no reciprocity agreement, employers have to consider the laws of both states. The state in which the services are performed will almost always require withholding from nonresidents who come into the state to work. In this case, withholding refers only to the wages for services performed in that state.

Employers’ Liability and Multistate Payroll Tax

The significant increase in employees working from home due to the COVID-19 crisis creates additional obligations for employers. This requires that they pay close attention to the income tax withholding and payroll tax laws of each state in which employees are working from home. Therefore, it is necessary to establish a system to keep up with multistate payroll tax regulations or changes to deadlines and avoid costly penalties.

Multistate payroll tax issues can be challenging, but also create a range of new opportunities for growing businesses across state lines. Instead of tracking payroll taxes manually and potentially facing errors and fines, employers should consider using payroll tax software. With such an approach, they can automate compliance for both regulatory and reconciliation accuracy while keeping up with deadlines and regulations in a variety of jurisdictions.

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