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Payroll Tax Basics: Beyond Federal Employment Taxes

Payroll tax compliance impacts any organization that employs people.  Compliance can be simple for small enterprises which do not offer benefits and have operations limited to one state—but the complexity of complying with state laws increases as organizations grow, offer more benefits and operate in more states.

LandrumHR has worked with many clients with various operations, so we understand the gamut of the scenarios encountered by employers.  It is interesting how state payroll taxation compliance has changed during the 40 years of our operations. 

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So what changed?  
Probably one of the biggest changes affecting payroll tax compliance results from an organization changing how they operate—more businesses are operating in more states with employees who telecommute or travel.  This newfound mobility creates a myriad of questions related to which tax jurisdiction applies to an employee—and the answer to that question often impact the business’s corporate filing requirements.

Here are a few basics that employers should know especially when expanding into new states:

1. There Are Different Types of Taxes

  • State withholding taxesMost states require withholding of state income tax on both residents and non-residents working in those states. 
    • Multi-state employees present challenges to compliance because the employer must have knowledge of state rules and a record keeping system that can track work performed in various states. 
    • Proper withholding of monies earned by multi-state employees requires that employers know which state the employee is domiciled (permanent resident) in addition to knowing which states they work.  There are several factors involved with this determination—including which state issued their driver’s license, where they are registered to vote, etc.  A person may live in a state but not be a resident so the withholding rules for their domiciled state may still apply. 
    • There are certain exceptions for employees of interstate carriers—these include aircraft pilots, truck drivers, etc.
    • States that do not have an income tax include Alaska, Florida, Nevada, Tennessee, Texas, Washington, and Wyoming.
  •  Local withholding taxesA few states require tax withholding of local taxes from employees and may also require the employer to pay a local payroll tax.  Employers may not be aware of these requirements until notified by the municipality. 
    • States that have municipalities requiring the withholding of local payroll taxes include Alabama, Colorado, Delaware, Kentucky, Indiana, Maryland, Michigan, New York, Ohio, Pennsylvania, and West Virginia. 
    • Employers may have local payroll taxes due if they employ people in California, Illinois, Missouri, New Jersey, Nevada, New York, Oregon, and Pennsylvania.
  • State Unemployment taxesAll states assess an unemployment tax.  Florida recently changed their tax from an “unemployment” to “reemployment” but it continues to serve the same purpose—to pay benefits to workers who were discharged from work involuntarily (not for misconduct).  This is an insurance for those workers funded from the Federal and State unemployment taxes. 
    • Unemployment taxes in some states contain more than one component to the tax—meaning that there is a main rate plus additional taxes.  For example, South Carolina adds an additional “contingency assessment” fee in addition to the unemployment tax rate.  If an employer’s rate is 1.17% and the contingency assessment is .06% then the employer’s actual rate is 1.23%. 
    • Some states—like California, New Jersey and Pennsylvania—require employers to withhold unemployment taxes from the employees in addition to what the employers pay. 
    • Employers may have difficulty in determining which state to report multi-state employees.  These are the questions that should be asked when determining which state to report state unemployment wages:
      • Which state does the employee perform their work? 
      • Where is their base of operations?
      • Where do they receive direction/control?
      • Where do they live?
  • Disability and other types of Insurance—States, such as California and New Jersey, also require the employee or employer to also pay a disability insurance premium.  New York also has a state disability fund as well that employers can contribute to cover their employees.  This coverage provides income to employees if they are unable to work.

Pay attention to your record keeping!

  • Timekeeping systems are key to ensuring that employees are properly recording time to capture information needed to comply with federal and state taxation rules.  Taxing agencies will hold employers responsible for non-compliance—these fines can be hefty.
  • Implement and enforce policies requiring employees to submit documentation.  The IRS maintains clear expectations of what employees should submit for expense reimbursements for non-taxable treatment.  Various employees and employers challenged these requirements many times and the IRS often prevails.
  • Reconstructing records for audits often results in the taxing agency rejecting those records.
  • Remember that the states are also improving their record keeping systems as well—specifically, they are integrating and sharing information to identify inconsistencies or non-compliance.  

Ask questions!

  • Understanding the employee’s task is often key to understanding what taxing jurisdictions apply and what questions to raise.  Sometimes payroll tax practitioners will need to ask questions to the Human Resource managers or to the employee in order to get the information needed to determine proper compliance to federal and state laws.
  • Ask where more information is available to learn about compliance.  Compliance requires some level of assessment of risk and understanding options.  Often there is not a clear answer, so having more knowledge of a subject helps when making determinations on tax-related questions.
  • Keep your business tax preparer and compliance team informed before expanding operations into a new state.  Many business owners are not aware that hiring someone in another state generally requires the business to file additional tax returns, change their workers’ compensation policies, and subjects their organizations to additional state laws.  Raising these questions before acting will minimize the impact to the organization and will better enable an organization to have a smoother transition when expanding into a new state. 
  • Be ready to answer questions!  Employees often need assistance in understanding taxation rules and their filing requirements.  Asking questions to the employee and communicating that information will minimize surprises (and unhappy reactions from employees).

Payroll taxation compliance is a critical function for businesses.  We may not like paying taxes, but it is a necessary part of maintaining a government that can protect us and provide amenities that improve our lives.  Always remember that any decisions made about taxes should be made after a careful review of the facts and all of the applicable laws. 

PS: If this article is making your head spin – know that our experts are here to help!  Visit our Contact Us page to ask us any questions you may have regarding payroll tax compliance.