It’s every business owner’s favorite time of year: tax season.
To all but the most voracious number crunchers, the task of filing taxes can lead to its fair share of headaches. For businesses with remote employees, the headaches can turn to migraines when balancing types of employees, differing state tax needs, and more.
As a company with employees and freelancers across 10 states, we’ve learned a few things about managing tax needs for a remote team. In this article, we’ll break down:
- The different types of remote workers — and how to classify and tax them.
- Considerations for establishing payroll taxes for remote employees.
- The importance of conducting tax compliance reviews.
What are the types of remote workers?
To establish payroll taxes for remote employees, business owners must first understand the classifications of different types of remote workers and how to tax them.
Part- and full-time employees
Part-time and full-time employees vary on factors like the number of hours they work and the legal protections and benefits they receive. When it comes to taxation, they have one thing in common: businesses must withhold taxes for their benefit.
These employees, often called W-2 employees, get their name in reference to the tax form they receive from their employer each year. Business owners are responsible for withholding social security tax, income tax, Medicare tax, and state income tax on behalf of every W-2 employee.
Our staff writer Lauren Wingo defined independent contractors as “employees [who] do their work apart from the organization or company for which they provide their services.” These employees do not receive the same benefits as W-2 employees and may contract with multiple organizations at the same time.
Unlike W-2 employees, contractors receive a 1099-NEC form from their employer during tax season. This means they are responsible for paying federal and state taxes themselves.
In a sole proprietorship, an employee establishes their own company and uses it to invoice the business they provide services for. Companies will not withhold tax on a sole proprietor’s behalf, similar to independent contractor tax treatment. Instead, the sole proprietor remains responsible for paying their own income taxes, such as self-employment and estimated taxes.
Related article: How to Manage and Engage Your Remote Team
How do I set up payroll for remote workers?
How you establish payroll taxes for remote employees will depend on their worker classification. Once you identify the types of workers on your payroll — and the necessary corresponding tax documents — select the payroll method that best meets your business needs.
Online service providers can help small businesses manage payroll taxes for remote employees without the need for a dedicated, in-house accounting team. Platforms like Intuit Quickbooks, Rippling, and the aptly-named Remote provide guidance and an easy-to-use interface for managing the payroll, benefits, and tax needs of your nationwide workforce.
While automated online payroll services have gained popularity among businesses of all sizes, companies can also process payroll manually or outsource the task to an accounting firm. Outsourcing to a dedicated payroll agency allows employers to leverage the expertise of financial experts and ensure payroll runs smoothly. However, it can also be expensive, which prompts many business owners to opt for in-house payroll instead. If you decide to process payroll manually, your accounting team should understand tax and labor laws at the local, state, and federal levels — and know how these laws apply to remote employees.
What if my employees work out of state?
Managing payroll taxes for remote employees who work out of state presents more hurdles than taxing in-state employees. While you may need to account for local income taxes that vary across city or county lines (in the case of an in-state employee), withholding taxes for out-of-state workers means navigating regulations at the local, state, and federal levels.
Types of out-of-state employees
Your company can maintain compliance by understanding the different kinds of out-of-state employees and their tax needs.
Employees who commute across state lines
If your organization has multiple locations, expands to a new state, or adopts remote or hybrid work policies, you may need to manage payroll taxes across state lines. Different states have different tax rates, so confirm each state’s commuter guidelines to ensure the protection of out-of-state employees from double taxation. Remote employees can request a reciprocal agreement granting them exemption from income tax withholding in one of the two states from their employer.
Employees who live out of state and work from home
For remote workers who live out of state and work from home, employers withhold income taxes based on the employee’s state of residency. You’ll report these withholdings directly to the state tax office where your remote employee works rather than the state in which your company is registered. Obtaining a Certificate of Residency from out-of-state employees helps ensure compliance.
Employees who temporarily work in another state
Employees in the middle of a move or other major life change may work out of state temporarily. They may not remain a permanent remote employee but for a finite period. In general, employers will withhold taxes and report wages to the state agency where the employee performs the majority of their work — not the state where they temporarily reside.
Taxing remote out-of-state employees
Employers typically pay payroll taxes for remote employees in the state where the employee works. Companies are responsible for registering with the state and local tax agencies where their employees are located. In some cases, employers will also need to register with the unemployment agencies of employees’ respective locales.
Because employers pay taxes based on their employees’ location rather than the business’s registered location, they must familiarize themselves with the unique tax liability rules of each state. Some states may provide withholding credits for taxes paid in other states. Other states may not impose their withholding requirements unless the employer demonstrates a significant economic presence in the state. The nine states without a state income tax (Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming) do not require businesses to withhold at all.
Take time to understand the specific state tax laws that apply to your remote employees to ensure your company abides by local regulations. A tax compliance review can help you understand these regulations and is necessary any time an employee from a new location is hired.
What is a new tax compliance review?
A tax compliance review examines state and local tax laws to determine the withholding and registration requirements for a new remote employee’s state of work and residence. The review may help employers determine what impact new remote hires will have on the business’s tax processes and finances.
The Internal Revenue Service conducts compliance checks to help employers determine whether they are adhering to tax laws and filing requirements. These voluntary checks educate employers about reporting expectations and can make it easier to maintain compliance when managing taxes for a remote workforce.
Interested in learning more about remote work and culture? Follow our blog to read articles about establishing remote employee engagement, running remote charity events, and more.