How Do I Hire an Employee in Another State?
As the pandemic goes into its third year, we’re experiencing a work-from-home revolution. Remote positions have leapt from just 4% of available jobs in North America to over 15% today, and this number is expected to rise to 25% by 2023.
Remote work, or telecommuting as it’s more traditionally known, can bring both opportunities and challenges to your business. While you now have access to a much broader talent pool of more healthy, more productive prospects, you’re also being asked to meet workers’ rising expectations of flexibility. The truth is, if you don’t adapt to this new reality and embrace the work from home revolution, your competition will.
Here’s everything you need to keep in mind from a financial perspective before you hire an employee out of state, including the four most important tax considerations:
Prep Before You Hire
Before you jump the gun and start sending employment offers from coast to coast, you need a foundation of important prep work.
The very first step is registering to do business in the state you wish to hire an employee in. Exact application requirements will vary from state to state, but you can find general guidelines through the SBA.
If you don’t have a physical presence in the state you wish to hire in – as in, you don’t have an in-state address to have documents sent to – you may need to hire a Registered Agent. This is someone who can receive official documents on behalf of you or your business to help you with the process.
On top of registering to do business, you’ll also need to think about what licenses, permits, and certifications you may need to conduct business in a new state. Because this isn’t a financial matter but an HR one, we’ll leave it to the experts: read more about that here.
First Tax Consideration: Income Tax
After you’re registered and legally permitted to do business out of state, you now need to set up your new employee’s payroll taxes. As an employer, you’re required to deduct a sum from your employee’s gross wages to be paid directly to the government in their name. But which state do you remit an out-of-state employee’s income tax to?
The golden rule of taxes is that they’re owed in the place where work is done. This is based on something called the Source Income Principle, which states that a country or state has the right to tax income that was generated within their jurisdiction.
All of this is a complicated way of saying that you need to register to withhold income tax in the state in which your employee lives and works, not the state where your business is.
Some states have what’s known as a Reciprocal Tax Agreement, so an employee who lives in one state but works in another can avoid double taxation. If the state your business is in and the state where your new employee lives have reciprocity, you’ll need to acquire a non-residency certificate from your employee. Read more about that here.
Second Tax Consideration: Unemployment Tax
On top of withholding income tax, most states also require you pay into their unemployment tax program. Most state unemployment tax agencies are a separate entity which you’ll need to register with and notify that you’re hiring an out-of-state employee.
Once you’re registered, you can set up State Unemployment Insurance, or SUI, tax to be automatically withheld by your payroll provider. Gusto – Red Earth’s payroll platform of choice – has a helpful article on how to do that here.
Third and Fourth Tax Considerations: Sales and Corporate Income Tax
With all your payroll taxes handled, you can now hire an out-of-state employee. Nice!
But your work isn’t done yet.
An out-of-state employee opens up another string of considerations you need to keep in mind for your sales and corporate income tax liabilities. These taxes rely on a concept known as nexus – or “the link between a taxpayer and a state that provides the state with the legal authority to impose its tax laws upon the taxpayer.”
Basically, there is a threshold of contact with a state your business has to surpass before you become subject to their tax laws. This contact can be created by:
- Physical presence
- Factor presence, like sales, property, or payroll
- Economic presence, like a certain volume of transactions
By hiring an out-of-state employee, you might push your level of contact with a state over the threshold and establish a nexus with them.
Unfortunately, there is no uniformity of nexus requirements across states, and a series of influential rulings by the supreme court and rapidly changing COVID relief regulations have made things even murkier.
Stay on Top of Changing Laws and Regulations
In their article on tax implications of COVID-19 Telecommuting and Beyond, The CPA Journal explores how a number of states are currently debating nexus laws that would have huge impacts on the company’s conducting business there.
At the beginning of COVID, many states issued guidance stating that, if an employee’s presence in their state was the result of COVID-19, it would not create nexus. However, these guidances largely expired in 2021. Some states haven’t set an end date for their guidance yet, which brings the risk of a sudden change in tax liability when and if they revert back to standard nexus laws.
To tell you what you already know, we’re in a time of great uncertainty and change. That doesn’t mean you can’t take steps to continue building your business and reaching new levels of success. It simply means you need to go in with as much preparation and care as possible, especially when it comes to your finances.
Keep Diligent Books
We’ve talked before about why it’s so important to invest in your accounting, and the importance has only grown with the work from home revolution.
If you hire a remote employee and establish nexus, you’ll need to apportion the income and expenses generated exclusively in their state. Your books need to have a clear separation so you can report only the finances relevant to that state on your corporate tax returns and stop yourself from overpaying. This requires diligent bookkeeping and a clear understanding of varying tax laws.
Hiring remotely allows you to access more talented workers who can take your company to new heights. But, like any business decision, it needs to be done strategically. That’s what we’re here to help with. At Red Earth, we use finances to give you the freedom and power to get where you want to go. From the early days of a startup, to scaling, to planning a savvy exit strategy, we’ve got your back every step of the way. Learn more here.