One of the more difficult aspects of tax compliance for employers is dealing with employees who travel outside of their state of residence for business purposes. The challenge is that states have varying standards and obligations for employers to withhold income taxes on employees traveling to nonresident states for temporary work-related reasons. These withholding rules have been described as a “patchwork of laws.” As a result of this non-uniformity, administrative oversights occur - even when the employee worked in a particular state for just one day. The uncertainty in this area is so widespread that in March the U.S. Senate introduced a bill that would allow a state to tax only working employees who either reside in the state or are performing in-state work duties for more than 30 days during a calendar year.
Anyone who has held a job knows that their home state taxes them on, well, everything – interest, dividends and especially wages. States, however, are limited by the U.S. Constitution to imposing taxes on nonresidents on personal income derived from sources within the state. For example, New York reflects this constitutional restraint on the states’ power to tax nonresidents by applying its nonresident income tax to income “derived from or connected with New York sources.” When it comes to wages, the rules for determining the portion of a nonresident employee’s compensation attributable to the state generally reflect the amount of time that the nonresident employee spends working in the state or the amounts attributed to the specific services rendered within the state. Interestingly, this means that a taxpayer does not have to work an entire day to have wages constituting in-state compensation. The object of state withholding is to have an employer withhold an amount which approximates the amount of tax that the employee will owe when they file their personal income tax return and to have the employer remit such funds in advance on the employee’s behalf.
Keeping track of the state requirements on employer withholding in nonresident states is very complex due to the fact that states have various standards. These thresholds may be based on working days that an employee is in the state, wages paid to an employee for services performed in the state, or some combination of those criteria. Approximately 25 states mandate employers to withhold income taxes from wages beginning with the first day a nonresident employee travels to that state for business purposes. Other states, however, have different standards. For example:
- New York provides that a nonresident employee must be in the state for more than 14 days in a calendar year before an employer is required to withhold taxes.
- Connecticut, a few years ago, changed it's 14-day rule to a 15-day rule, meaning that as long as the nonresident employee performs personal services in state for 15 days or less, the individual's compensation is not deemed Connecticut-sourced and is not subject to the state's income tax. As a result, employers are not required to withhold Connecticut tax from this compensation
Other states provide for a wide array of standards, such as:
- Arizona allows for 60 in-state work days before requiring the withholding taxes;
- Georgia has a 23-day rule or a $5,000 wage threshold if earned in the state;
- Idaho enforces withholding when in-state wages exceed $1,000; and
- South Carolina requires withholding after the first $800 of in-state compensation.
It is important to note that the above withholding thresholds typically do not apply to the individual income tax filing obligations of the employee. This disconnect between the withholding and income tax rules further complicates compliance and may trap unwary employees who are not aware of their reporting obligations.
Due to the disparate, and often irreconcilable, state approaches towards nonresident withholding many problems arise. First, many employers have to manually track their employees’ physical location on a daily basis, resulting in a high administrative burden that prohibits compliance. Second, payroll departments and systems are generally not equipped to effectively manage employees with multiple work places and to compute the applicable state taxes to be withheld. Finally, states tend to audit nonresidents more rigorously than in-state residents, which may cause onerous tax examinations and frivolous tax assessments.
In today’s business environment, employees continually crisscross the country as part of their employment obligations. While this tends to promote economic growth, it also makes it difficult for employers to achieve tax compliance. Meeting the requirements of the assorted state nonresident withholding laws is quite challenging. If you require assistance with respect to your nonresident employee withholding obligations, please contact Alan Goldenberg, Principal of State and Local Taxation and Tax Controversy, at firstname.lastname@example.org or 212-897-6421, or your Friedman LLP tax advisor.