Payroll in Practice: 10.10.2023

Question: A college recently hired instructors to teach online courses. Some of the instructors live and work from their homes or offices located in states other than the state in which the college is located. Should the college withhold tax for the state where the employee is physically located or for the state where the college is located?

Answer: Withholding is usually required for the state where the employee is physically located when working. There are some cases in which withholding may also be required for the state where the employer is located. For example, withholding may be required under “convenience of the employer” rules or for services performed by the employee in the state where the employer is located.

In most cases, an individual’s income is included in the tax return of the state in which the individual is a resident, regardless of where the income was earned. If a worker performs services while physically present in another state, the income earned while working in that other state will be included in the tax return of that state. Usually, to avoid having the same income taxed by both states, the state of residence will grant a tax credit for the taxes paid to the state where the income was earned.

When the employer is in one state and the employee lives and works in another state, the income is usually only subject to tax by the state where the employee lives and works. Whether the employer is required to withhold tax for that state is a separate question. This depends upon state withholding rules and whether the employer has a significant business connection to the state, known as nexus. State laws vary with respect to withholding and nexus rules.

Having an employee working within a state may be sufficient to create employer nexus. With respect to payroll, when nexus is created for a particular state, the employer becomes subject to the payroll laws and regulations of the state. In addition, the employer may become subject to other business taxes such as corporate income taxes, franchise taxes, and sales taxes.

It is imperative that an employer knows where its employees are working. Otherwise, compliance issues or inadvertent creation of nexus may arise. If an employer is considering hiring an employee to work in a state for which the employer does not currently have nexus, the employer should consult with legal counsel to determine whether the employee’s work in that state will create nexus. If so, the employer will likely have to register as an employer for that state and comply with its payroll withholding and reporting requirements.

Six states have convenience of employer rules including Connecticut, Delaware, Nebraska, New Jersey, New York, and Pennsylvania. These rules require a worker to pay tax where the employer’s office is located if the employee works remotely for convenience rather than necessity.

Using a New York-based employer as an example, if an employee performs any services in New York for that employer during the year and also performs work in another state where the employer does not have a bona fide business reason for locating the employee, all of the employee’s income is taxable in New York. The income might also be taxable in the other state under the physical presence rules.

Nine states do not have an income tax on wages. If the employee lives and works in one of these states, then no withholding is required. The states are Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. No tax should be withheld for the employer’s state unless the employee works in that state or the convenience of employer rules apply. The District of Columbia does not tax income of nonresidents earned within the District.

This column does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Patrick Haggerty is the owner of a tax practice in Chapel Hill, North Carolina, and an enrolled agent licensed to practice before the Internal Revenue Service. The author may be contacted at phaggerty@prodigy.net.

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