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Post-pandemic, more and more companies have embraced non-traditional working arrangements, specifically remote and hybrid roles. This shift initially occurred out of necessity, but now, most workers prefer to work flexibly rather than be tied to a desk in a single physical office. On top of that, businesses have realized the monumental benefits of hiring distant employees – quicker access to talent, reduced overhead costs, better employee retention, and more.
Whether you’ve already hired employees across state lines or are planning to, it’s vital to understand the financial implications for businesses that work with out-of-state employees. One of the most mystifying is managing payroll taxes.
If your business hires talent from outside of the state, you could benefit from learning all you can about payroll taxes for out-of-state employees. And we plan to help in this guide covering just that. We’ll also explain how these specialized tax situations work, information about registering your out of state employees for payroll, and more.
The Rundown on Payroll Taxes for Out of State Employees
Tax responsibilities for businesses with employees across state lines are more complex than those that hire from the local talent pool. But with the right information and some guidance, you can successfully manage payroll taxes for these distant employees. We’ll cover everything you need to know in the sections below.
Which States Should You Withhold Taxes For?
Because state payroll taxes aren’t centralized, there’s no one-size-fits-all rule regarding how an employer should treat payroll taxes for out-of-state employees. But, there are several potential scenarios and courses of action to consider.
The primary goal is determining which state government the taxes should go to.
- Withhold only for your business state: In most cases, you’ll withhold payroll taxes where your business is established. So, even if your employee is working out of Ohio, if your business is located in Kansas, you’ll follow Kansas’s payroll tax laws.
- Withhold for multiple states: Sometimes, you’ll be required to withhold taxes for multiple states, depending on the state governments and rules in play.
- Withhold only where the employee lives: When states are situated close to each other – think Iowa and Indiana – the governments enact reciprocity agreements where workers will only owe taxes in the state they live in. So, let’s say an employee works for an Indiana employer and they live in Iowa; they’d only pay taxes in Iowa.
As an employer with a distributed workforce, we encourage you to get familiar with state tax regulations. Start with the state government where your business is located and then explore the tax government where your employee lives.
Want to know which states have reciprocity agreements with each other? View this resource for that information.
Factors Complicating Income Tax Regulations for Out of State Employees
Several factors may complicate the payroll tax situation for businesses like yours. We’ll outline them below to put them on your radar:
Hybrid work arrangements permit workers to clock in at home, at your physical business location, or as they’re traversing the world.
The longer an employee works in a given area, the higher the probability of having to remit taxes to that new location. Laws vary widely in this area by state. So, your office may need to look into the tax laws for any number of states. This can quickly become labor-intensive, especially as you expand your team with more remote or hybrid employees.
Changing regulations can make it difficult to stay abreast of every employee’s tax withholding obligations.
It may seem like once you’ve got your head above water, more changes are on the horizon. That’s why it’s so important to stay updated on tax news.
Variations in Tax Obligations by State
For your information, it’s important to know how each state handles income taxes. There are two tax rate types in the U.S. – the flat income tax and the graduated-rate income tax. And some states have no income tax at all.
- Flat income tax – Everyone pays the same income tax rate.
- Graduated income tax – The income tax rate increases based on income.
The following information comes from the Tax Foundation and is current as of January 2026.
| State | Tax Rate |
|---|---|
| Alabama | Graduated |
| Arizona | Flat |
| Arkansas | Graduated |
| California | Graduated |
| Colorado | Flat |
| Connecticut | Graduated |
| Delaware | Graduated |
| District of Columbia | Graduated |
| Georgia | Flat |
| Hawaii | Graduated |
| Idaho | Flat |
| Illinois | Flat |
| Indiana | Flat |
| Iowa | Flat |
| Kansas | Graduated |
| Kentucky | Flat |
| Louisiana | Flat |
| Maine | Graduated |
| Maryland | Graduated |
| Massachusetts | Graduated |
| Michigan | Flat |
| Minnesota | Graduated |
| Mississippi | Flat |
| Missouri | Graduated |
| Montana | Graduated |
| Nebraska | Graduated |
| New Jersey | Graduated |
| New Mexico | Graduated |
| New York | Graduated |
| North Carolina | Flat |
| North Dakota | Graduated |
| Ohio | Graduated |
| Oklahoma | Graduated |
| Oregon | Graduated |
| Pennsylvania | Flat |
| Rhode Island | Graduated |
| South Carolina | Graduated |
| Utah | Flat |
| Vermont | Graduated |
| Virginia | Graduated |
| West Virginia | Graduated |
| Wisconsin | Graduated |
The following states don’t have an income tax:
- Alaska
- Florida
- Nevada
- New Hampshire
- South Dakota
- Tennessee
- Texas
- Washington
- Wyoming
For the above states, you don’t need to deduct state withholding. But in some cases, if you have remote workers, the regulations may be different.
Handling Payroll Taxes for Out-of-State Employees: Payroll Tax Registration & More
With the background information out of the way, let’s dive headfirst into the process of withholding payroll taxes for out-of-state employees. Here’s the thing – the process will differ a bit based on the state governing authority. However, the process will generally follow the below steps (including payroll tax registration, researching regulations, etc.):
1
Pinpoint your employee’s work location.
Find out where your workers are completing their work duties and determine how the laws are set up in those applicable state(s). There will be times when you need to withhold income for multiple states for an employee. And there will also be times when no state tax is due.
2
Get your employee registered with the appropriate state tax agency.
Payroll tax registration will require targeted research into the authorities where your employee resides, where your business is located, or where the work is being completed. Be proactive about this step, as the registration process may require fees, elongated processes, or fast-approaching deadlines.
3
Ensure your payroll tax software has been configured to manage multi-state payroll.
It should also allow you to manually manipulate the employees’ withholding.
4
Tax Compliance Reminder
Withhold any state taxes per the regulations in place for all applicable states.
5
Comply with any state payroll tax requirements.
For instance, in Illinois, employers with 25 or more workers have to file a special employer’s contribution and wage report. The equivalent of this form may be required for other states as well.
6
Make it a point to stay up to date on what’s happening in the tax industry.
At any time, any state can impose changes to its payroll tax regulations. You’ll need to be watching for those changes so you can make proactive updates and remain compliant.
How to Ensure Ongoing Compliance with Payroll Taxes
Many businesses have come into trouble in their attempts to abide by the laws surrounding payroll taxes for out-of-state employees. But you don’t have to. Here are some tips to remember as you navigate this situation.
First, educate yourself on payroll tax regulations and subscribe to scholarly information and news outlets. Check back on a frequent basis to stay updated. Also, be very careful when choosing your payroll software – for the best results, choose one that will roll out updates geared toward compliance.
Aside from those things, be sure that your payroll team is trained on the latest regulations and procedures surrounding payroll taxes for out of state employees. Human error can very quickly lead to compliance violations. Ensure they can audit the payroll software and its executions and identify problems. And place a strong emphasis on continuing education.
Here are a few other tips to keep in mind:
- Keep your employee records well-kept and accurate. Keep their tax filing status, exemptions, work location, state of residence, and other tax-related details organized. And keep them on file for three years.
- Pay payroll taxes on time. Check with state authorities and adhere closely to the given timelines.
- Audit your payroll records from time to time to catch any withholding issues that could land you in hot water.
Penalties for Payroll Tax Violations
Accurate payroll tax withholding, contributions, and reporting are infinitely important for all businesses. Noncompliance can quickly lead to penalties, which typically take the form of fees based on a percentage of the tax deficit.
Your company could also be reported to federal and state authorities and be sanctioned per their internal procedures. And in the worst cases, applicable parties can find themselves on the receiving end of a jail or prison sentence.
Where to Get Help with Payroll Taxes
Depending on your level of comfort with payroll taxes, you may need full or part-time assistance. Here are a few professionals that can help you with your specific payroll tax situation:
- Accountants and CPAs
- Payroll service providers
- Tax professionals and enrolled agents
- Business consultants
- Small business development centers (SBDCs)
So, there you have it – the basics on payroll taxes for out-of-state employees. We hope you found all the information you were looking for and wish you the best as you educate yourself on the topic.
