Benjamin Franklin said that taxes are one of life’s few certainties. While that statement is as accurate as ever today, complications from the COVID-19 pandemic shed light on the uncertainties of tax issues, namely, how we pay taxes on our remote work.
As remote work becomes a popular model, employees and employers must better understand how this type of employment works when paying taxes. After all, misunderstandings at tax time often result in severe financial penalties for employers and employees alike.
Read on to explore essential tax considerations for remote employees, like how and where they pay taxes.
How does remote workers’ state income tax work?
The tax that employees are most familiar with is the income tax. There’s the federal and state income tax—depending on where you live. For remote workers, the federal income tax remains straightforward. Because the federal government levies these taxes, where you live doesn’t matter.
State income taxes are where tax payments get tricky for remote workers. Remote workers must also pay state income tax or local taxes depending on the worker’s state of residence. Also, cities like New York impose local taxes in addition to state and federal tax credits and tax liabilities.
Since remote work allows employees to live in a different state than the one they work for, confusion often arises: Which state income tax do you pay?
How do taxes work across states with remote work?
Confusion often arises when a worker lives in one state but works remotely for an organization in another.
Generally, the state a remote worker pays income tax to the state in which they are a resident. You technically work in your home state while working for an organization from another state. Therefore, expect to pay state income tax to your home state.
You earn your income in your state of residence—provided you’re working from home. Therefore, you pay income tax to your home state. Where you work is the primary factor determining to whom you pay state income tax.
For instance, if you work remotely in the same state as your organization (whether that’s Arkansas or California), expect no complications about who receives your state income tax. However, extenuating circumstances often require remote workers to file a nonresident state tax return (for example, if they live in one state and work remotely in another).
How taxation works for different types of remote jobs
Remote work does not necessarily mean working from home or in your primary domicile. Regarding remote workers state income tax, working from home means paying state income tax to your home state. But not all remote workers “work from home.” To illustrate the different scenarios that remote work often refers to, let’s explore different types of remote work arrangements.
1. Out-of-state commuting employees
Work arrangements often arise when an employee commutes to work from out of state. In this case, they work in a state that is not their residence. These instances sometimes arise when people from New Jersey commute to New York City or Washingtonians commute to Portland, Oregon.
For remote workers using hybrid models, this situation arises if they commute from their out-of-state residence to the office a couple of days a week.
These hybrid commuters would be in a situation where they would need to pay state income tax for both states. However, they sometimes reduce the tax they pay each state by reciprocal agreements. Reciprocal agreements are tax arrangements where taxpayers often file for exemption of state income tax for one state, avoiding double taxation.
2. Workers living out-of-state who work from home
Remote workers sometimes don’t live in the same state as their employer. Remote workers who work from home earn an income in their state of residence and therefore pay state income tax to their home state. In most cases, the remote employee would not have to pay taxes to their employer’s state.
However, some states have the “convenience of the employer” laws. As the name suggests, these states require employees to pay taxes as per the employer’s state, not their state of residence, where they work from home. States with convenience of the employer rules include Connecticut, Delaware, Nebraska, New Jersey, New York, and Pennsylvania.
3. Temporary out-of-state employees
Remote work opens up many possibilities. A particularly complex one is a situation wherein an employee is temporarily working remotely from another state, both outside of their employer’s state and their state of residence. Because where the work occurs is one of the primary determinants of where a remote worker pays income tax, temporary remote conditions are often confusing.
Whether remote workers pay income tax to the state where they work temporarily depends on the duration of their stay. Different states have different guidelines on the length of time that warrants an employee to file a non-resident tax return. Remote workers in these scenarios often look up their local state laws to determine the time required to file in their temporary state. Otherwise, the only state income tax these remote workers need to pay is their state of residence.
4. Digital nomads
Digital nomads are remote workers who use their remote capability to travel while they work. Naturally, this invites a tricky scenario for paying state income tax: If digital nomads travel all the time, to which state do you pay personal income tax?
Like the temporary remote workers mentioned before, digital nomads often have to file non-resident tax returns depending on their stay in a given state. More often than not, digital nomads move around at a fast pace. If their trips are shorter, they only need to pay state tax to the state where they reside—their home state.
5. Full-time remote employees
Remote employees must consider where they live and where they work when filing their taxes. A full-time remote employee doesn’t necessarily work in a different state from their employer, so filing is no different than if they commuted to the office.
However, if the remote employee works in a different state, they likely pay state income tax to their home state rather than their employer’s state. Of course, this situation depends on where they live. If they live in a convenience rule state, they often need to pay taxes to their employer’s state or file for exemption via a reciprocal agreement.
6. Hybrid remote employees
Employees on a remote work schedule sometimes get confused if they live in one state and work in another. If the employee and employer reside in the same state, there likely won’t be much complication when tax time comes.
However, if the employee resides in a different state than their employer, their hybrid schedule sometimes requires them to pay taxes in the state where they live and work from home and the state to which they commute. There are often mitigating factors in reciprocal agreements that usually exist between the states involved.
Remote work taxes in and outside the United States
Remote workers typically pay federal and state taxes when working within the United States, depending on their remote work arrangement and their state of residence. Depending on their situation, remote workers sometimes have to file a non-resident tax return.
Still, what about remote workers working outside the United States?
Tax considerations in an international context get very confusing very fast. There’s a lot to consider: Is the taxpayer an American citizen? Do they work for an American organization? How long are they abroad? Do they live abroad permanently?
American citizens working abroad have to pay taxes to whatever region they live in; remember, in most scenarios, you have to pay taxes where you do the work.
However, American citizens working for American companies often still need to file tax returns, even if they don’t owe anything to the United States government. Furthermore, U.S. citizens who earn above a certain threshold—over $100,000 a year—may be required to pay taxes to the United States government even if they are earned money outside the country.
Employer’s remote work tax implications
Employees aren’t the only ones paying taxes. Employers pay payroll tax on an employee’s behalf as per federal law. Payroll tax includes Social Security, Medicaid/Medicare, and federal and state unemployment taxes.
Employers continue to pay payroll tax for remote employees even if they work from home in another state. In these cases, they simply withhold state taxes like income tax as per the tax codes of their employee’s home state.
Because employers are required to make these withholdings, they need to know tax rules about their remote workforce. For instance, some states have little to no state taxes. Here are a few to consider:
Alaska
Alaska doesn’t have a state payroll tax. Employers don’t have to make any state withholdings for Alaskan remote workers.
Florida
Florida does not levy a state income tax. However, they have a state unemployment insurance tax, meaning employers don’t have to withhold state income tax. Still, they must make state unemployment withholdings for Florida remote workers.
Nevada
Nevada does not have a state income tax but a state unemployment tax.
New Hampshire
New Hampshire does not tax income made from wages, nor do any local jurisdictions.
South Dakota
South Dakota does not have a state income tax.
Tennessee
Tennessee does not have a state income tax.
Texas
Texas law forbids the state from levying a tax on income.
Washington
Washington State does not levy a state income tax.
Wyoming
Wyoming does not levy a state income tax.
3 tips for tax reduction when working remotely
Taxes are a certainty, but they don’t need to be as burdensome as you think. Ensure you pay your fair share by implementing these three tips to reduce your tax payments.
1. Understand the contractor/employee dynamics
Filing your taxes requires you to have a clear line of communication with your employer. When you know what they are required to pay, you will better understand what you are required to pay.
For instance, knowing your employee classification often significantly impacts what taxes you pay at the end of the year. W-2 employees have to pay different taxes than 1099 freelancers or temporary independent contractors; exempt and non-exempt employees have differing tax burdens. Make sure you know what you are filing so you know how to file.
2. Learn about local tax laws
Tax laws change based on your location. Every state has a different set of tax codes. Localities within your state, like local taxes specific to your town or city, influence what you pay at the end of the year.
Learn as much as possible about local tax laws. When you’re crystal clear on what you need to pay, you reduce your risk of overpaying or incurring tax penalties.
3.Consider including EOR to optimize employment
To say taxes are a complicated affair is a massive understatement; let’s just say there’s a good reason accountants exist. Understanding the breadth of your tax situation is like taking on another career. That’s why seeking help is essential when you’re feeling lost.
An employer of record (EOR) is an excellent resource for employees and employers struggling with taxes. An EOR is a third party that ensures you are one hundred percent compliant with the specifics of your tax situation.
A last word on working remotely and paying taxes
Remote work is celebrated by workers across industries primarily because it presents workers with more freedom. However, when neglected, the tax complications of remote work present significant downsides.
They don’t need to be.
Payscale offers location-based pay solutions that untangle all the complexities of your tax situation. Our compensation plans handle the specifics of your tax requirements, down to the details of your locality.
