Chapter 17

How to Apply Payroll Taxes for Multistate Employees

Businesses that have employees in multiple states face quite the challenge in filing the necessary paperwork with various California taxation agencies. Increasing the complexity is whether the Economic Development Department (EDD) determines if the work performed in each state constitutes nexus.

Failure to file these forms and not collecting and remitting the correct amounts of withholdings can trigger a sales tax audit. In this chapter, I am going to focus on how much you need to withhold from your employees’ pay and whether or not there is reciprocity between the states where your employees work. 

California has reciprocity with all of its surrounding states. 

Companies that have workers in various states will have to keep the following payroll taxes in mind: Personal Income Tax (PIT), Employment Training Tax (ETT), Disability Insurance Tax (SDI), and Unemployment Insurance (UI) Tax. Employers are responsible for remitting the ETT and UI taxes and they must properly withhold PIT and SDI from the employee’s pay. 

Whether an out-of-state business will have to pay PIT in California will again depend on whether its activities are considered nexus-creating. The EDD states that having a California resident perform work exclusively outside of the state is, by itself, not sufficient to trigger a payroll tax requirement for an out-of-state business. (Multistate Employment Information Sheet).

Instead, companies that do business, derive income from within the state, or are otherwise governed by California’s laws are responsible for remitting and withholding payroll taxes. (Multistate Employment Information Sheet). The amount of personal income tax an employer must withhold will vary based on the earnings of the employee.

If you are a business owner and need help figuring out if you owe taxes in the various states where you have employees, give me a call. We can help you determine nexus, withholding amounts and set up a schedule of filing deadlines and payments. 

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How Much Payroll Tax to Withhold

To get a better sense of what the numbers may look like, the state has published the 2020 withholding schedules for calculation through the Wage Bracket Table Method (“Method A,” for incomes below $1 million) and the Exact Calculation Method (“Method B”).

The amount of UI and ETT tax a business has to pay will be a certain percentage of the first $7,000 in wages that the business’ employees earn. The percentage a business will pay yearly per employee whose earnings surpass $7,000 can range from 3.4 percent ($238, for the first two to three years) to 6.2 percent ($434). For the ETT tax, employers can expect to pay 0.1 percent or $7 per employee earning over $7,000.

For calculation of the UI, ETT, and SDI taxes, all jurisdictions use the Localization, Base of Operations, Place of Direction and Control, and Residence of Employee tests. 

(California Unemployment Insurance Code (UIC) §602); (California Employment Development Department Information Sheet). 

By walking through each of these tests, companies can be better equipped to make the right choice regarding where it must remit payroll taxes for its multi state workers. However, California companies can simplify the process by filling out Form DE2325, Employer’s Election to Cover A Multi‑State Worker Under The California Unemployment Insurance Code (22 CCR § 454(a)-1). 

Any state that has signed on to the Interstate Reciprocal Coverage Arrangement may elect to remit taxes to only one jurisdiction in which the multistate employee is performing their services. All jurisdictions with the exception of Alaska, Kentucky, Mississippi, New Jersey, New York, and Puerto Rico have signed on.

Reciprocal Agreements for Payroll Taxes

While a business may have employees who live in one state and work in another, not all such situations will require tax withholding from each of the states in question. Various states have reciprocal tax agreements which allow employees working and living in two different states to request an exemption from taxation in one of the states. (TurboTax’s list of the current reciprocal agreements between the states). 

For example, Arizona has reciprocity with California so California residents working in Arizona can opt out of having Arizona taxes withheld by completing the state’s Withholding Exemption Certificate

If an employee receives an exemption, they may present their employer with an exemption form. Once the employer has received the proper documentation, it can withhold taxes from the employee’s home state only rather than from both jurisdictions.

Applying Payroll Taxes to Your Multistate Employees

Multistate business has grown exponentially, especially with the uptick in online commerce. It is not uncommon for a business to have employees not only in California but across the nation, especially if the business ships merchandise from different states or has its customer service personnel working remotely from different regions.

While this type of organization is obviously more efficient and certainly advantageous from a health perspective, it can cause some real headaches for employers. There are many withholding forms that the employer must file with different state taxation authorities.

Fortunately, there are a multitude of online resources to help you determine withholding amounts and whether the different states have tax reciprocity and the good news is that only a handful do not. (California is a reciprocal state.)

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