If we have employees working in more than one state, what are our state tax withholding obligations?

The general default requires employers to withhold state taxes in the state where the work is performed by the employee. In today's mobile and remote workforce and multistate business environment, it is sometimes difficult to determine employer withholding obligations. Although a tax attorney should review an employer's specific obligations, it is helpful to understand the following key concepts and definitions when evaluating the employer obligations.

Source Income Principle

The source income principle indicates that states have the right to tax income that was sourced (earned in the case of wages) in their states. For example, an employee lives in Kansas and works in Missouri at company headquarters. Missouri is the source of income as the employee performed the work in that state. Therefore, the employer would withhold Missouri taxes for the Kansas resident employee.

Reciprocal Agreement

The reciprocal agreement is an agreement between states (usually bordering states) that allows employers in states with such agreements to withhold based on the state of the employee's residency instead of the state where the employee performed the work. Using the example above, an employee works in Missouri but lives in Kansas. If Kansas and Missouri have a reciprocal agreement, the Missouri employer can withhold Kansas taxes for the employee who works in Missouri but lives in Kansas.

The examples above may be somewhat clear, but what happens if an employee works at different client sites in different states throughout the tax year? There is no uniform answer in such a situation. Some states use thresholds such as the number of days an employee visits (works) in the state. For example, a state may have a limit of 60 visits. This means an employer must withhold taxes on employee earnings after the employee has worked more than 60 days in that state. Some states use an income-level threshold where income earned (wages paid) at or above a certain dollar amount for work performed in that state is subject to state withholding.

In addition to employer withholding obligations, employees have personal income tax obligations that may not parallel an employer's withholding obligations. For example, if an employee works in one state but lives in another where no reciprocal agreement exists between the two states, the employee may have a personal income tax liability in both states. Regardless of the employees' personal income tax obligations, the employer must comply with the proper state withholding obligations. This could result in an employee paying taxes in both the state of residency and the state where work is performed. It is recommended to review state withholding obligations and consult with an experienced tax expert for any complex situations. State income tax withholding forms may be obtained from respective state revenue offices.

Convenience of the Employer Rule

Some states have what is known as a "convenience of the employer rule," which requires employers located within the state's borders to tax the income of all employees, even those working remotely in another state. An exception exists if the employer requires the position to be remote, rather than the employee choosing to live and work out of state for personal reasons. For example, an employee working for a New York employer who works out of state by choice will owe New York state taxes. The other state might not offer a credit (known as reciprocity) and might also tax those same wages. Connecticut, Delaware, Nebraska, New Jersey, New York and Pennsylvania all use the convenience of the employer rule.