Hiring remote employees gives companies access to a larger pool of workers, but because each state has its own laws regarding workers' compensation, disability insurance and/or paid leave, as well as its own taxing authority, employers have to know and be prepared for the implications on state and federal income taxes when it comes to remote workers, Medicare withholding and unemployment insurance.
Different taxation requirements apply to different types of remote worker roles. Here are the categories to consider:
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Employees vs. independent contractors. Employers do not withhold taxes for contractors. Employers do withhold and pay taxes for
employees, and this is generally based on where the employee works, not where they live. (It is important to understand the difference between employees and contractors to avoid
misclassifying them.)
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Residents vs. nonresidents. For employees who live in the same state as the company, employers pay any state and local taxes as well as
state unemployment insurance taxes and withhold state income taxes. For employees who reside out of state or even out of the country:
- Employers generally pay tax in the state where the company is, but some states have so-called reciprocal agreements that allow taxes to be paid in the employee's state of residence.
- If the employer's company has a multistate presence, including in the employee's state of residence, the employer will have to follow specific rules to avoid double taxation. However, the employer will pay state unemployment tax to each state — and each state has its own rates. You will also need a state ID number in each state to withhold and remit taxes for remote employees.
- Most countries outside the U.S. require companies to have a local business presence before they can hire remote workers; after that, employers follow local tax laws and regulations. (International wires may be subject to bank fees, transfer fees and exchange rates.)
Know the rules
Most states have specific rules that determine whether certain types of payroll taxes apply to nonresident employees. Additionally, some localities have their own taxes and tax rules. In some jurisdictions, local taxes apply only to residents, while in others, taxes apply to anyone who works within a jurisdiction’s limits. State and local tax rates and regulations may change from year to year, so you'll have to create a way to stay up to date. Each state may have different workers' compensation insurance requirements. (It is possible to integrate workers' compensation with your payroll to ensure the insurance premium is accounted for.)
One often-overlooked point is that unless you have a policy requiring employees to notify you when they plan to change locations, you may fall out of compliance unintentionally.
Hiring remote workers and keeping up with state rules, rates and forms relevant to remote working and taxes, all of which are governed by laws in a state or country different from yours, come with intricacies. You may want to work with an accountant and/or payroll provider that's familiar with local, state and federal tax and labor laws to help you stay up to date on changes from year to year.