Multiple State SIT | consulting

Income Taxes for Multiple States – Who Has Jurisdiction?

Many employees don’t live in the state where they work, or they may temporarily work in a different state. What state income taxes should be withheld from an employee’s paycheck, and to which state does he pay taxes?

Every state that has a state income tax (SIT) has different regulations regarding the definition of income and the obligations of employers and employees with regard to the withholding of taxes and the filing of income tax returns, so the only way to have a definitive answer to the above questions would be to check the tax laws of each of the states involved. However, there are some general rules of thumb that can be applied in most situations.

What Is the Definition of Income Subject to State Income Tax?

Almost all states with an income tax will tax individuals on the following income:

If the individual is a resident of the state, then all income earned by the individual is subject to the income tax.
If the individual is not a resident of the state, then only income earned in the state is subject to the income tax.

So if an individual lives in one state and works in another, he usually has to file an income tax return in both states. However, this does not mean that the taxpayer is double-taxed. Most states have a provision that allows a taxpayer to take a credit on the tax return for the state where he lives for taxes paid to another state. That means that first he has to prepare the tax return for the state where he works, and then he completes a form or schedule on the return for the state where he lives to take a credit and reduce the tax he pays to the state where he lives.

How Do Reciprocal Agreements Affect State Income Tax Withholding?

There is one major exception to the above rules. Some states have signed reciprocal agreements. If two states have a reciprocal agreement and an individual lives in one of those states and works in the other, the individual will only be subject to the income tax in the state where he lives. All states with reciprocal agreements have provisions that exempt an employee from having the tax withheld for the state where he works, but the employee has to complete a withholding exemption form to avoid withholding.

Employers are not required to withhold the tax for the state where the employee lives. On the other hand, even though it is not mandatory, a great many employers will establish an account with a reciprocal state and withhold the tax for the employee's state of residence.

If a taxpayer lives and works in states that have a reciprocal agreement, then he only has to file an income tax return in the state where he lives. If his employer has withheld the income taxes for the state where he lives, then he can report that amount on his annual income tax return. However, if his employer does not withhold the tax for the state where he lives, he will have to set aside the money from each paycheck and make estimated tax payments quarterly to his state department of revenue.

What If an Employee Works in Another State on a Temporary Basis?

The rules presented above seems relatively simple, but when an employee travels to another state and performs work there, things can get extremely complicated. As mentioned before, each state that collects state income taxes has different laws, and this can apply even to local income taxes as well.

For instance, in the City of Philadelphia whenever a visiting sports team plays in Philadelphia, the income earned by each player of the out-of-town team is subject to the Philadelphia City Wage Tax (CWT), and each team has to have an account with the Philadelphia Department of Revenue and withhold the tax from the players' paychecks. Since no employee files a tax return with the Philadelphia Department of Revenue, the Philadelphia CWT is a tax that must be collected at the source, so the burden of collecting the tax and remitting it is on the employer.

On the other hand, other states may have a grace period of time before SIT must be withheld, or there may be a minimum amount in wages earned first. For instance, an out-of-state employee has to work at least 60 days in Arizona before an employer must begin withholding Arizona SIT. Georgia allows up to 23 days each quarter before an out-of-state worker is subject to Georgia income tax. In Wisconsin the threshold is based on earnings because an employee may earn less than $1,500 before he is subject to the state's income tax. Of course, if an employee works in another state and exceeds the limit, then taxes will have to be withheld retroactively to the time when the employee began working in the state.

This all places a heavy burden on the employer, because the employer must research the tax laws for each state in which an employee performs services.

One final observation: A distinction can often be made between working in another state and being paid while in another state. For instance, an employee who is paid to attend a training conference or a professional meeting is not performing services, so he is not actually working in the state.

To sum up, an employer can usually follow these general rules:

If an employee works and lives in the same state, then withhold the SIT for that state.
If an employee works in one state and lives in a reciprocal state, then withhold for the reciprocal state.
If an employee works in one state and lives in another, and there is no reciprocal agreement, then withhold for the state where the employee works.
If an employee temporarily works in another state, and the time worked in the other state or the amount earned is in excess of the state's limit, then withhold for the state where the employee has been working.
If an employee temporarily works in another state, and the time or amount earned is less than the state's limit, then withhold for the state where SIT is normally withheld.

So withholding state income taxes when multiple states are involved can be a complicated matter, but employers can avoid the pitfalls by doing their homework ahead of time.