Multi-state Income Tax: for Which State Must Employers Withhold?

Issue: You are working in the payroll department of a company that employs a significant number of out-of-state telecommuters, as well as employees who commute to your location from neighboring states. What are the general rules regarding state income tax withholding in multi-state situations?

Answer: If your company has operations in more than one state, you may be faced with income tax withholding obligations for more than one state. Sometimes, you may even have to withhold income tax for more than one state from the same employee. Withholding can get even more complicated when you have employees who live in a different state than the one they work in or who perform services in more than one state.

Deciding which state’s income tax to withhold can be a confusing process. How do you determine who is a resident and whether you should follow the laws of the state of residence or the laws of the state where services are performed? Not all states answer these basic questions in the same way, and sometimes state laws conflict.

The default rule of state income tax withholding is to withhold income tax for the state in which services are performed, according to guidance from the Internal Revenue Service and the Social Security Administration. This rule can be applied in most situations where the employee lives and works in the same state (assuming it is not one of the nine states without income tax withholding: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming).

Three other withholding rules shoul