As more companies embrace remote work, employers need to be aware of the various rules and regulations that can apply to remote employees. The implications of remote work crossing state lines can be complex and, if not properly managed, may create significant administrative burdens or legal problems for employers.
In this article, we will discuss the key considerations for managing remote workers across state lines.
Managing compliance: tax, compensation, benefits, and labor law considerations
Understanding employee classification and its significance
It’s crucial to understand the distinction between W-2 employees and independent contractors, as it affects not only payroll management but also various labor laws and regulations.
For W-2 employees, employers are required to withhold state income taxes, Social Security, Medicare, and federal income taxes, while independent contractors are responsible for managing their own tax obligations.
The IRS generally classifies workers as independent contractors if the workers control how, when, and where the work gets done, with employers only directing the desired outcome of the work. Independent contractors have more autonomy in deciding how and when to perform their work, and they often provide their tools and equipment. Independent contractors generally do not receive the same benefits and protections as employees, such as minimum wage, overtime pay, or workers’ compensation coverage.
It is important to note that worker classification can vary by state, with certain laws, such as California’s Assembly Bill 5 (AB5), making it more challenging for businesses to classify workers as independent contractors.
The classification of workers significantly impacts the tax obligations and legal responsibilities of both employers and workers. For employers, proper classification is essential to ensure compliance with tax laws and avoid penalties. Misclassifying an employee as an independent contractor can lead to fines, back taxes, and liability for unpaid benefits.
Understanding tax residency for payroll-related taxes
Tax residency for remote employees working across state lines is typically determined by factors such as domicile, physical presence, and source of income. Each state has its own set of rules and criteria to establish tax residency. Some common factors include:
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Domicile: the primary state where an individual maintains their permanent home or intends to return after temporary absences. It is usually the state where the employee is registered to vote, has a driver’s license, and files their state income tax return.
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Physical presence: many states have a day-count rule, where an individual is considered a tax resident if they spend more than a specified number of days (e.g., 183 days) within the state during a tax year.
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Source of income: employees may be subject to income tax in the state where they perform their work, even if they are not residents of that state.
In some cases, an employee may be subject to withholding in two or more jurisdictions. This can happen when an employee is considered a tax resident of one state (based on domicile or physical presence) but works in another state or has sourced income from multiple states. In such situations, the employee might be subject to income tax withholding in both their resident state and the state(s) where they earn income.
Many states have reciprocity agreements or offer tax credits for taxes paid to other states to prevent double taxation. As of 2022, the jurisdictions with reciprocity agreements include Arizona, Illinois, Indiana, Iowa, Kentucky, Maryland, Michigan, Minnesota, Montana, New Jersey, North Dakota, Ohio, Pennsylvania, Virginia, West Virginia, Wisconsin, and Washington, D.C.
State unemployment insurance reporting and taxes
Federal law provides standardized tests to determine which state should receive unemployment insurance contributions. These tests are designed to ensure that employers typically do not report wages and taxes to more than one state for an employee in any quarter, except for employees relocating permanently during a quarter. In such cases, employers might need to report wages and taxes for that particular quarter to both the previous and new state of residence, though this scenario is an exception to the general rule.
These tests, known as the “Localization of Work” tests, help identify the proper state for unemployment insurance (UI) tax reporting. They are applied in the following order:
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Localization Test: if the employee performs all their work in one state, the employer should report UI taxes to that state.
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Base of Operations Test: if the employee works in multiple states but has a base of operations in one state, the employer should report UI taxes to the state where the base of operations is located.
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Place of Direction and Control Test: if the employee works in multiple states and doesn’t have a base of operations, the employer should report UI taxes to the state where the employee receives direction and control (typically where the employer’s headquarters or main office is located).
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Residence Test: if none of the above tests apply, the employer should report UI taxes to the state where the employee resides, provided the employee performs some work in that state.
In some cases, it is possible for an employee to be subject to income tax withholding in one state and unemployment insurance contributions and reporting in another state. This situation might occur when an employee works in multiple states or when the state of residence differs from the state where the work is performed.
Workers’ compensation
Employers must also cover remote employees under workers’ compensation policies. Determining which state’s workers’ compensation laws apply to a remote employee may not always be subject to the same localization of work tests used for unemployment insurance. While these tests can provide guidance, workers’ compensation insurance requirements are often determined by factors such as the employee’s primary work location, the location of the employer’s base of operations, or the state where the employee was hired. Each state has its own criteria, so it’s essential to consult with the respective state agencies or expert advisors to understand the applicable rules.
In some cases, an employee might need to be covered by workers’ compensation insurance in more than one state. This can happen when an employee regularly performs work duties in multiple states or when the employee’s primary work location is different from the state where they were hired. Under these circumstances, an employer may need to modify their existing policy to ensure adequate coverage and compliance with the specific laws of the state where the remote employee is working. The additional coverage could potentially increase the employer’s insurance costs, as different states may have varying rates, coverage requirements, and benefit structures.
Employee benefits
Remote employees working in different states may also raise questions about employee benefits. Employers should consult with their benefits department or insurers to ensure compliance with local regulations and avoid potential issues with the employee’s access to an established healthcare network.
For example, a company based in State A might offer health insurance benefits through a preferred provider organization (PPO) with a network of healthcare providers specific to State A. If the company hires a remote employee who lives and works in State B, the employee may have limited or no access to the healthcare providers within the PPO network in their state of residence. In this case, the employer might need to offer alternative health insurance options that provide adequate coverage for remote employees in State B.
Another issue is the variation in state-mandated benefits. Some states may require employers to offer specific benefits, such as paid family leave, short-term disability, or additional health insurance coverage, which may not be required in the employer’s home state. Additionally, different states may have different rules governing the administration of benefits like flexible spending accounts (FSAs), health savings accounts (HSAs), and retirement plans. Employers must ensure that their benefits packages meet the requirements of each state where their remote employees are working.
Complying with local labor laws
Employers must also adhere to local labor laws in the jurisdiction where the remote employee works. Compliance with these laws ensures that remote employees receive the same legal protections as other employees working within that locality.
Some local labor laws may include:
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Minimum wage requirements. Different states, counties, or even cities can have varying minimum wage rates. Employers must ensure that remote employees receive at least the minimum wage prescribed by the jurisdiction where they work. This may require adjusting wages for remote employees to comply with local regulations.
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Mandatory breaks. Some states require employers to provide mandatory meal and rest breaks based on the number of hours worked.
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Overtime rules. Employers must be aware of the specific overtime regulations in each remote employee’s jurisdiction and accurately track and compensate employees for any overtime working according to local laws.
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Leave policies. Some jurisdictions have specific leave policies, such as paid sick leave, family leave, or even bereavement leave, which may differ from the employer’s standard policy.
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Recordkeeping and notices. Employers may also need to comply with specific recordkeeping and employee notice requirements. This can include providing employees with notices or posters outlining their rights under local labor laws.
Having remote employees in different jurisdictions adds complexity and administrative challenges for employers. In these situations, it is even more important to rely on your accountants and payroll service providers for individualized advice, especially if your remote employees expose you to additional rules and regulations.
Tax nexus for corporate-level taxes
Remote employees can potentially expose employers to state corporate or business activity taxes due to the concept of nexus. Nexus refers to a business’s connection to a state, which determines its tax obligations in that jurisdiction. When an employer, who previously didn’t have a recognized office in a particular state, now has an employee working there, they may be required to comply with local regulations.
For instance, employers may need to register with the secretary of state and relevant authorities in the new state, provide a registered agent address, and pay business activity taxes. In addition to corporate taxes, having a remote employee in a different state may also trigger sales tax obligations.
Moreover, some states may require employers to file annual reports or adhere to other regulatory requirements set by the state where the remote employee is working.
This article is intended to provide a brief overview of rules and regulations that may apply to remote workers in different jurisdictions. It is not to be construed as legal advice, nor is it a substitute for speaking with an expert advisor. For more information, please contact our office.
