Employees Working out of state
Some employees are still working at home and will keep doing so in the future. If you have employees working out of state, this can create additional tax and payroll challenges.
State income tax withholding for employees
When it comes to payroll tax withholding, state withholdings primarily follows the rules of the state where the work is performed. If employees who live out of state come to your business for work, payroll would follow the withholding rules for the state where your business is located. These employees may owe income tax to their state of residence. Employers can withhold partial amounts for the residence state in addition to the worked-in state.
There is an exception when two states have a reciprocity agreement wherein the governments agree that residents only owe income tax to the states where they live, not where they work. If this applies to your workers, you should already be withholding taxes for the state where your employees live. Without a reciprocity agreement, taxes may need to be withheld in both the state in which work is performed as well as the residence state.
Income tax rules for working out of state
If your employees work from home in a different state for number of days that exceeds the established threshold for that state, the employer must generally recognize the change and begin to submit taxes to the state where the employee is working, not where the business is located. This threshold varies by state — for instance, in New York it’s 14 days, but in Illinois it’s 30. Other states have an income threshold, or a combination of time and income. If you are an Alabama employer with Alabama residents working outside the state of Alabama, you will need to withhold Alabama income tax on those residents unless you are withholding tax for the state in which the employee is working in.
Another factor some state governments consider is whether the employee is working from home for their convenience or as a necessity for their job. If it is for the employee’s convenience, then tax withholding should be withheld for the state where the business is located. If working from home is a job necessity, then payroll is sourced through the employee’s state of residence. But state laws and rules vary considerably on the specifics. Alabama will not consider temporary changes in an employee’s physical work location during periods in which temporary telework requirements are in place due to the COVID-19 pandemic to impose nexus or alter apportionment of income for any business.
Another related problem deals with tax “nexus”, which is where a business has an established presence in a state, it may be required to pay sales tax, income tax, and other business taxes for that state. In some states, having employees working in the state is enough to establish nexus, which could lead to further tax compliance requirements for your business.
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