A common arrangement these days is to allow employees to telecommute from home a few days a week. What if that employee lives in a different state than their usual place of business? You may have to deal with the complex challenges of allocating wages amongst these two states and not even realize it.
Generally, employers are required to withhold state income tax based on where the work is performed. This could also apply to employees that travel between different satellite offices as well. Although this sounds simple at the outset, there are different rules depending upon the state:
- You need to make sure your organization is registered with the Department of Revenue, and
- Collect and remit state income tax withholding for all states in which work is performed.
Additionally, there are major differences in how some states treat the taxation of certain benefits. Most states follow federal tax treatment; listed below are a few exceptions to this rule:
- California – employee contributions to a Health Savings Account (HSA) are considered taxable. Any employer contributions to an HSA are considered income for state reporting purposes.
- New Jersey – employee contributions to an HSA are considered taxable. Health insurance premiums paid through payroll deductions must be made on an after tax basis.
- Pennsylvania – 401(k) deferrals are included as income.
These differences make it extremely difficult for payroll systems to accurately allocate wages amongst these states.
Another challenge employers are faced with is when an employee lives in a taxing state that is higher than the state in which they work. When this occurs, the employer is expected to treat the work state as the “primary” taxing state and, if registered in the employees’ resident state, withhold the difference in tax as a “secondary” state withholding tax.
Finally, withholding income tax from nonresidents is another area that requires close attention to detail. Generally, the state in which the employee performs work is the primary taxing state. However, some states have reciprocal agreements with surrounding jurisdictions. If you have an employee that resides in a state that has a reciprocal agreement with the state in which they are employed, you should withhold state income tax based on where they reside rather than where the work is performed.
As you can see, this can get quite confusing. When it comes to taxes, if you’re in doubt, seek the advice of a tax expert.