Multi-state payroll refers to when an employee lives in one state but works in another and additional considerations must be taken into account when determining taxes.
What is nexus?
As if payroll wasn’t complicated enough, it really gets fun for companies who are running multi-state payrolls. Multi-state payroll refers to a payroll where employees live in one state but work in another. Sometimes, employees will live in one state but work in multiple states throughout the course of the year. Suddenly under these scenarios, a whole host of additional considerations must be taken into account when determining what taxes to withhold from an employee’s paycheck, most notably whether the company has nexus, whether the two or more states have reciprocity agreements, and whether the employee has a nonresident certificate on file for the states where he or she is working but not residing.
Nexus means “connection.” In the tax world, nexus refers to a business’s connection between a taxing jurisdiction, such as a state, county, township, etc. If a business is said to have “nexus,” it means the business has a tax presence in that jurisdiction. Nexus applies to both sales tax and payroll tax. We’ll focus on nexus as it comes to payroll tax.
Nexus is something a business can “have.” At the most basic level, if a business has nexus in a state, it means that the business has a presence in the state, and therefore subject to state income taxes within the state. A business has nexus in a state if it owns or leases property in the state, derives income from within the state, has capital or property in the state, or employs personnel in the state in activities that exceed “mere solicitation.” Nexus requirements vary from state to state.
When it comes to payroll withholding, if a business has nexus in a state, the employer is subject to the withholding laws of that state. In this scenario, the employer may have to withhold income tax for an employee’s state of residence even though he or she performs no services there just because the employer has nexus in that state.
In 2012, the Virginia Tax Commissioner ruled that an out-of-state employer was required to withhold Virginia income tax from compensation paid to a sales employee who worked from a home office in Virginia because the employee’s presence created nexus [Virginia Department of Taxation, Ruling No. 12-37, 3-30-12]. Thus, the presence of even one employee in a state may be enough to establish nexus for withholding tax purposes in some states.