My employee lives in one state and works in another. How does the tax work?

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My employee lives in one state and works in another. How does the tax work?

If your employees live and work in different states, here are the terms to know:

Nonresident state: This is any state that you commute to for work or work in for a short amount of time, but it’s not your permanent home.
Resident state: On the other hand, this is your permanent home. Think back to the return address label on your holiday cards. Most likely the address is located smack dab in your resident state.

Now, ask yourself these questions:

Where does your employee work? Do they work from home or do they travel to work someplace else? If the answer isn’t obvious, do some sleuthing.
If the state they live in is different than where your company is located, is there a reciprocal agreement between the two states? If not, has your employee requested courtesy withholding?

In most cases, you have a withholding responsibility in the state where your employee actually works, which can either be their resident or nonresident state.

So if your company is based in Michigan, but your employee works from home in Georgia, you would withhold income tax and pay state unemployment tax in Georgia only.

What’s the deal with reciprocal agreements?

Here’s where things get tricky. Depending on where your employee lives, they may be able to withhold their income tax in their home state. This allows them to file one tax return each year, which helps simplify things.

All those state friendships happen through something called a reciprocal agreement. The agreement is formed when neighboring states rally together and agree that people who work in nearby states can pay income tax to the state they live in.

Example: Since Illinois has a reciprocal agreement in place, a person can work in Illinois, but pay income tax in their home state if they live in Kentucky, Michigan, Wisconsin, or Iowa.

If there’s no reciprocal agreement between your employee’s home and work state, it’s not the end of the world. Your employee will most likely have to pay both nonresident and resident state income tax. But luckily, most states grant a tax credit to cover the pesky cost of being taxed twice.

Pro tip: You can help those who have to pay income tax in states without reciprocity by offering a courtesy withholding from their paycheck. It’s when employers withhold both sets of state income taxes so employees don’t have to deal with a cash crunch during tax season.

How do I set up reciprocal withholding?

Your employee will need to complete a non-residency certificate to excuse them from tax withholding in their work state. Once they’re done, they’ll send it your way for safekeeping. You won’t have to mail it in, but be sure to lock it up somewhere safe.

When you receive the certificate, let your payroll provider know that your employee has an agreement in place, so they’ll withhold the correct amount in their home state.

Looking for a certificate? Here’s a template you can use.

Common scenarios

To paint a better picture of this whole multi-state employee business, below are a few situations you may find yourself in — and how to deal with them:

1. Your employee resides in Dallas, but works in Oklahoma City.

Although your employee lives all alone in the Lone Star state, you will have to pay taxes for them in the Sooner State.

2. Your employee works from home at their ranch in Wyoming, but your company is located in bustling Manhattan.

You will have to pay all of their state taxes to Wyoming, because that’s where the work is actually being completed.

3. Your employee lives in Maryland, but they commute every day to your office in DC.

Maryland and DC have a reciprocal agreement in place, so your employee could request that you withhold their income taxes in Maryland, leaving you with only DC unemployment to pay on their behalf.

4. Your employee is working in Pennsylvania temporarily for three months.

For nine months, you pay taxes in the state where this person primarily works, and for three months, you pay taxes in the Keystone State.

As your team grows, you may find yourself hiring people from all corners of the country. No big deal, right? Everything looks squeaky clean until payroll taxes come into the picture.

Employees in multiple states can cause multiple headaches because each state has a completely different set of rules that govern this stuff. In this article, we’ll explain what to do with a team that works, travels, and lives from sea to shining sea.

First, the golden rule: You generally pay taxes in the state(s) where your employees work.

The twist is that state laws are, quite literally, all over the map. Therefore, it’s important for you to read up on the state legislation that applies to your team.

Need help paying employees in different states? See how Gusto can handle it for you.

If you live and work in different states, here are the terms to know:

Nonresident state: This is any state that you commute to for work or work in for a short amount of time, but it’s not your permanent home.
Resident state: On the other hand, this is your permanent home. Think back to the return address label on your holiday cards. Most likely the address is located smack dab in your resident state.