Mastering Multi-State Payroll in a Work-From-Anywhere World

The widespread shift to remote and hybrid work is forcing HR leaders to rethink not just workplace culture and performance management, but also how to manage employees across many locations. Expanding your workforce across state lines is complicated by the tax and labor laws present in each state. 

As a result, maintaining multi-state payroll compliance is a growing concern.

More than half (58%) of respondents to EY’s 2021 Global Payroll Survey said their top emerging payroll priority was assessing remote working policies and their impact on multi-jurisdictional payroll withholding.

Maintaining compliance with the patchwork of laws governing payroll taxes across states and local jurisdictions is a complex and increasingly important challenge for HR and payroll professionals.

This guide walks you through the intricacies of multi-state payroll so that you can maintain compliance with confidence.

Set Pay in Accordance With State and Local Laws

Pay is an important factor in mastering multi-state payroll compliance, which behooves HR leaders to set pay with intention — and in compliance with local regulations.

Review Wage and Hour Laws

The most important laws to refer to when setting pay are minimum wage requirements, which can vary significantly from state to state and even within local jurisdictions. Some states, such as Louisiana, Mississippi and Alabama, haven’t established state-level minimum wages and default to the federal wage of $7.25 an hour. Others have set their minimum wage at a higher rate. Some cities and counties have set separate minimum wage requirements, such as New York City, Denver and several localities in California.

When setting pay for employees across state lines, be aware of local laws and regulations governing pay minimums in locations where employees are based.

When managing employees across state lines, setting entry-level pay rates that are compliant and fair can be tricky. Tennessee and Missouri have comparable cost-of-living rates, for example, but Missouri has a set minimum wage that is significantly higher than Tennessee, which has no set minimum and defaults to the federally required $7.25 an hour. Employers with employees in both states may wish to set comparable pay to incentivize retention and maintain employee morale.

Update Overtime to Reflect Local Legislation

While many states default to the Fair Labor Standards Act governing overtime at the federal level, some states have enacted their own overtime laws. California, for example, has a double time law requiring employers to pay double the employee’s regular rate for hours exceeding 12 in a single workday or eight hours on the employee’s seventh consecutive workday.

When there is overlap between state and federal overtime laws, you’re obligated to follow whichever law is more generous to the employee.

Geographic Pay Differentials

Many organizations are introducing pay differentials to reduce labor costs — especially at technology companies, which have historically paid a premium for talent living in hubs like Silicon Valley that have a high cost of living.

While pay differentials are not typically regulated, some jurisdictions have geographic pay legislation in place for government jobs. Geographic pay differentials, also known as pay localization, refer to changes in pay based on where the employee is located.

In the case of the state of New York, for example, the director of classification and compensation can authorize geographic pay differentials for certain employees working in a specific area or location. An employee’s total pay, including the differential pay, cannot exceed a specific amount.

Right now, these laws apply specifically to government jobs. And not every state or local government has such laws. However, with the trend toward increased remote work, this is a topic you’ll want to monitor.

Contractors and Classification for Multi-State Employers

Contract workers are treated differently from W-2 employees on your payroll, which can complicate multi-state payroll compliance. The greatest risk is misclassifying an employee as a contractor, which can result in fines and back pay requirements. Different states have different definitions of what constitutes a contractor, which makes classification even more challenging for multi-state employers.

Many states use common law rules laid out by the IRS at the federal level to determine a worker’s classification. But some states, such as California, have adopted the stricter ABC test, and others still use different versions of the ABC test. Work with your legal counsel to manage the complexity of classification across state lines.

“Criterion fit our price point for a company of our size, but did not limit us in technology. Our org structure is different from the typical Human Resource/ Payroll company which most HCM or HRIS systems are geared towards. So for me it was about finding a software that allowed us to have control and input as to how we would like our system to look, feel, and operate without always having to put in a special request or ticket for “an upgrade”.” 

- Shameka Porter, Benefits Manager, Elevanta

Ensure Accurate State Income Tax Withholding

The most complex component of multi-state payroll is determining the right income tax withholding amount for each employee and which state should receive the withholding. Here are some of the factors multi-state employers need to consider when determining income tax withholding across state lines.

Determine Your Business Nexus

Economic nexus refers to a business’s relationship with a state or local tax jurisdiction in terms of economic activity. Businesses subject to nexus have a defined tax presence and are required to pay taxes in that state or local jurisdiction. 

In the past, nexus has only applied to businesses with physical operations within the state, but in the e-commerce era, that’s changed. In the 2018 decision South Dakota v. Wayfair, the Supreme Court ruled that states can mandate sales tax from businesses that attain a certain amount of sales or reach a transactional dollar amount, regardless of where the business is physically located. Similarly, businesses with an employee working remotely can trigger nexus in that state.

There are two primary categories of nexus: sales tax nexus and income tax nexus. 

Sales tax nexus is triggered by sales-related activity in the state, such as housing inventory, accepting or soliciting orders, or delivering your product via company vehicle in the state. Sales tax nexus has no impact on payroll. 

Income tax nexus, however, plays a significant part in maintaining multi-state payroll compliance. When your business has nexus in a state, you’re required to pay income tax there. Generally, income tax nexus is triggered by having an employee working within the jurisdiction.

Factor in Reciprocal Agreements

You may have employees who live in one state or tax jurisdiction but work in another. That situation creates another factor to consider with multi-state payroll tax compliance. 

To make this circumstance easier to handle, some states have reciprocal agreements with each other. These agreements make payroll across state lines less complicated. If the state where the work is being performed has a reciprocity agreement with the state that the employee lives in, then you only have to withhold taxes for the state where the employee is a resident.

It’s important to note, however, that even in states with reciprocal agreements, tax withholdings don’t kick in automatically. Employees need to file an exemption with your office. Educate them on that process and provide the tools and resources they need to make that happen.

The first step to payroll compliance for nonresident employees working in another state  is to review reciprocity agreements. In states without reciprocal agreements, employers are obligated to withhold payroll taxes for the state the employee lives in and the state they’re working in. Employees won’t be taxed twice on the same work, however. When these employees file their taxes, they’ll file with both states but will typically be credited the amount they’ve paid in their state of residence.

Account for Local Differences in Payroll Taxes

In addition to income tax requirements, payroll professionals for multi-state employers have to navigate differences in state and local payroll taxes. While most payroll taxes, like Social Security and Medicare, are taxed at a flat rate, others can vary by jurisdiction. 

States may have their own tax rates for short-term disability or paid family medical leave. In California, for example, paid family medical leave is included under the disability tax umbrella. Massachusetts, meanwhile, doesn’t have a payroll tax for disability but does tax family leave and medical leave at various rates.

These differences between state-specific payroll taxes introduce additional layers of complexity to your multi-state payroll process.

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Develop Standardized Payroll Guidelines

Although multi-state employers have to reconcile specific differences across the payroll process, difference doesn’t have to define your process. Developing standardized payroll guidelines can help your team better manage the complexity of multi-state payroll compliance.

Set a Basic Process

Given the complexity and difference inherent in multi-state payroll compliance, you probably can’t replicate exact payroll processes across every state you operate in. But you can set basic process guidelines that are flexible enough to accommodate state and local payroll regulations.

Guide your payroll administrators by developing written guidelines that govern basic payroll processes. Standardized processes for using your centralized payroll software, for example, can help ensure consistency across payroll processes, regardless of the differences within jurisdictions.

When payroll processes are standardized, it’s easier for local administrators to notice when something is off. Maintaining consistent processes also makes it easier for your payroll team to monitor the data being produced. Their ability to quickly flag potential errors improves the organization’s likelihood of compliance.

Many companies work with payroll vendors or consultants to ease compliance concerns. These service providers can help you customize process guidelines to meet the needs of your workforce.

Appoint a Central Payroll Team

A centralized payroll team can help enforce standardized payroll guidelines. Such teams can develop training to ensure that local administrators understand the intricacies of the payroll process and how to use your software appropriately.

Your guidelines should Include a chain of command for escalating payroll compliance questions. When payroll administrators can find answers to their pressing questions, they’ll make better decisions and significantly decrease the risk of noncompliance.

If a payroll administrator at the local level has concerns about how to treat income tax withholding for a nonresident employee, for example, they should know that it’s OK to ask for help and where to direct their question. A central payroll team can continue to refine standardized processes as questions or gaps arise.

“As a result of the partnership with Criterion, BAASS has been able to meet our customers HR administrative needs and provide strong tools for their employees and managers. Criterion is an agile company, regularly updating their systems to include enhancements. They continue to work closely with BAASS to make the solution a perfect fit for the unique needs of each of our clients.” 

- HR Manager, BAASS Business Services

Concentrate Payroll Operations Within a Central System

Multi-state payroll compliance requires tracking many moving pieces. A central payroll system can help payroll professionals at your business remain in compliance with state and local payroll requirements.

Consolidating your workforce’s payroll data makes it easier for payroll administrators and your central payroll team to see the same information. Having a single source of truth empowers better compliance.

A comprehensive payroll software system, equipped with geographic tax code information, can remove a lot of the uncertainty out of the multi-state payroll process. Hyper-granular tax and rate configurations, based on geocodes, can help you approach your multi-state payroll process with confidence.

“We went with Criterion based on their ability to handle granular union requirements in one complete software solution that pulls time sheets from our ERP, imports to payroll, and delivers the data back — all while calculating union rules from imported timesheets.  Granularity, service and one complete application with one database is the answer.”  - Heather Kinder, Controller, Traffic Plan

Conclusion

Multi-state payroll is complicated, and that complexity is only growing. Don’t let navigating the depths of this complexity stop you from hiring the best talent regardless of location. When you’re aware of the challenges inherent in multi-state workforces, you can create a comprehensive plan for maintaining payroll compliance.