There is simply no room for error in processing payroll because the results of every step will be put under a microscope.

Employees will look at each paycheck or direct deposit and, if it doesn’t match their expectations, they will drill down to every detail, from hours and rates to withholdings. Multiple taxing authorities will review remittances every pay period and investigate any anomalies. Even the company’s accounting operations will be examining discrepancies between the various data sources that feed payroll, tax payments, and benefits funding.

If you employ workers in multiple states, you can multiply the complexity and oversight by the number of states involved. Multi-state payroll has become a growing consideration for companies hiring remote personnel, even if they have only one office.

Add the fact that tax rates and labor laws continually change and you have a recipe for errors and distractions beyond the usual payroll mistakes businesses face. Here is what you need to know to catch problems before they occur:

What is Multi-State Payroll Processing?

The challenges of multi-state payroll processing stem from the laws and regulations of each state involved. Every state has regulatory regimes regarding taxes, terms of employment, and the related wages. These are on top of federal laws. In some cases, local laws by municipalities may also apply.

Compliance with these various laws is non-negotiable. Even if your payroll process generates an honest mistake, there may be penalties involved and interest charges on any shortfall. The time and expense involved in remediation impact the company’s bottom line. This can be especially tough on small and medium-sized businesses. In every case, these various factors need to be considered for every payroll run, and for every state involved.

State and Local Income Tax Withholding

While not every state collects income tax, federal income tax reporting requirements create a national data set that every state can reference for compliance with their tax regimes.

Most commonly, personal income taxes are due in the state where the worker is employed (the “work state”). If a worker lives in a state different from the employer’s place of business, income tax may also need to be collected for the state of residence and, on occasion, even the city.

This means withholdings need to be processed for multiple states. This also means workers need to file tax returns in both states for which the employer must supply the necessary documentation.

Federal, State, and Local Wage and Hour Laws

Federal laws serve as a baseline for minimum wage and labor law. But different states have different minimum wages and formulas for calculating wage ranges, sometimes varying by industry or work type.

For example, taxes for tipped employees may be calculated differently from salaried or strictly hourly workers. Likewise, child labor laws may differ in states with a large agricultural sector. A central resource for accessing these state laws can be found at the U.S. Department of Labor.

In addition to the complexities remote work adds to payroll processing, there is the issue of traveling employees. Field sales or support personnel may spend days or even weeks in a variety of “work states” during any particular period. Each state may have different pay or reporting requirements, though de minimis or exemption rules may also apply to such workers’ time so there are no tax implications.

This can affect processing and compensation for each pay period. Just as importantly, each payroll run generates a record of exactly what and how wage and labor laws are being applied. Any mistakes or misinterpretations are right there in black and white for anyone to flag. And administrators in every state are paid to spot them.

State Unemployment Insurance Regulations

Each state also has its own unemployment insurance program. Like the income tax system, there is a federal baseline, with a variety of state programs applied on top of that. Only a few states require employee contributions to these. But employers must account for all their employees, regardless of where they reside.

In the event an employee needs to draw on the unemployment system, it will not necessarily be in the state where they live. That generally means their employer must be funding it.

Reciprocal Tax Agreements

Because of scenarios where commuters work in one state while residing in another, many states have reciprocal tax agreements to minimize double taxation on those individuals. A list of the states that have entered into such agreements as of the date of publication can be found here.

These agreements give the state of residence first position in claiming tax authority over the employee’s contributions. These agreements also apply to remote workers. While this simplifies withholding and reporting in most cases, it still must be factored into the process.

“Convenience of the Employer” Rule

The “convenience of the employer” test for tax law interpretation has become more prominent since the rise of remote work. If the decision to work from home is for the “convenience of the employer” – because it saves the employer money or gives them a business advantage – then taxes must be filed in the state where the employer does business.

But if the employee works from home for their own convenience, they may be liable for taxes in both their home state and the state where their employer is located. Of course, the company’s payroll process needs to manage the necessary withholdings and reporting.

Best Practices for Multi-State Payroll Management

Whether you choose to process your payroll in-house or to outsource payroll processing, there are a few steps you should always take to make sure you’re compliant with all applicable laws. These are the best ways to avoid unnecessary hassle and expense.

• Stay updated on tax law changes and state-specific regulations. Even if you have someone else processing your payroll, it’s easy to make administrative decisions that impact multi-state payroll. The more you know, the likelier you will spot a problematic situation for further consideration before you make that decision.  

• Confirm potential local tax assessment liabilities for new hires. Make sure whoever is processing your payroll is flagging out-of-state employee residential addresses. Then make sure the applicable payroll implications have been investigated and applied.

• Maintain accurate payroll records. In addition to rigorous time-tracking and application of pay rates, direct employees to keep their personal information current. If you don’t have human capital management (HCM) software that automatically does so, make sure your payroll team is alerted whenever an employee’s address changes, along with any other details that might affect regulatory requirements.

• Send regular alerts to affected individuals when withholding or reporting requirements change. This is a good policy regardless of multi-state considerations, so employees aren’t surprised by unexpected deductions on their paycheck. But it’s especially helpful to ensure individuals living in different states don’t get overlooked.

• Implement automated payroll systems. If you’re going to process your own payroll, the more you can automate, the less likely you are to experience problems, especially for multi-state considerations which can easily be missed. Check out our guide to learn more about the advantages of payroll automation for small businesses.

In any case, always consult with your legal and tax advisors to determine the exact requirements for your operations and workforce.

Get Seamless and Compliant Payroll Across States with VensureHR

As you can see, running multi-state operations or employing multi-state personnel brings many added considerations for processing payroll. This may get completely overlooked if you bring on remote staff. But the consequences can be substantial.

For small and medium-sized businesses (SMBs), the complications can become too much of a distraction from their core business. If this is you, consider outsourcing your payroll processing. This is one of the many ways VensureHR can be a lifesaver for an SMB. Because of our size, national footprint, and technology-enabled solutions, VensureHR is perfectly positioned to address all the challenges of multi-state payroll processing.

To learn more about this service, explore this overview of our payroll administration capabilities.

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