Legal Requirements for Hiring Out-of-State Employees

While hiring out-of-state employees can provide many benefits for your business, doing so presents some challenges you should consider before moving forward.

Compliance laws vary, but every state has regulations pertaining to hiring, payroll, taxes, benefits, and other practices you’ll need to follow. If you plan to hire out-of-state employees, it’s a good idea to begin the process well ahead of time, as it requires preparation such as researching, communicating with state agencies, and preparing and filing applications. Registering for payroll tax in a different state can be particularly challenging, as tax regulations vary significantly, and maintaining compliance can be challenging.

In this article, we’ll explore the topic of nexus, which in this context links a business with a state and can trigger the need to collect and/or pay taxes there. In addition to registering for payroll taxes, we’ll look at some considerations for managing out-of-state payroll, and consider how hiring requirements can vary from state to state.

Preparing in advance to hire out-of-state employees can help be sure that your business is operating legally in every state and assure a smooth transition after the hire has been completed.

Knowing if You Have Nexus and What to do About it

Nexus implies that a business is in some way connected to a state, and therefore subject to collecting and paying taxes there.

A business is generally considered to have nexus with another state under these circumstances:

• It has employees working there.
• It has a store, office, warehouse, or other physical presence there.
• It has no physical presence in the state but has a certain level of economic activity or income there. Many states consider a company to have nexus and require it to pay sales tax if it has more than 200 sales transactions or $100,000 in sales within the state in one year.

Determining whether your business has nexus in another state can be tricky because there’s no universally shared definition of what nexus is, and rules regarding it vary significantly from state to state. Also, states tend to regularly change their rules around nexus, making it the responsibility of business owners to research and stay on top of any changes.

If you already have employees in another state or are considering hiring some, I’d suggest you err on the side of caution and assume that you do have nexus. In most cases, nexus occurs when an employee works in a state other than the one in which the business is registered, regardless of whether the individual resides in that state. So, if your business is registered in Michigan and you have two employees working in Illinois, you probably have nexus in Illiniois.

Having nexus with another state means you’ll need to register for payroll there and probably also apply for foreign qualification. Foreign qualification, if you’re not familiar, is the process of applying to do business in a state other than the one in which your company is registered. To foreign qualify in another state, you must register your company with that state’s Office of the Secretary of State, or comparable agency. Foreign qualifying enables you to operate in another state without having to form and register a new business entity.

You’ll need to find a registered agent in the state where you have nexus, as many state agencies will only send documents to a physical address within the state.

Managing Out-of-State Payroll

An employer with out-of-state employees must comply with the payroll tax rules of the state where the employees perform their work.

Keep these key considerations in mind as you hire your first out-of-state employees:

• You’ll need tax accounts in every state in which you have employees, and you must calculate withholdings for employees according to their state’s tax rates and regulations.
• Payroll taxes are federal and state taxes that employers are required to deposit and report on behalf of their employees. Also called employment taxes, they include withholding from employees’ paychecks to cover federal—and when applicable—state and local income taxes.
• Individuals who live in one state and work in another might owe state income tax in both states, although some states have reciprocal agreements allowing residents to only pay income tax to the state in which they live—not the one where they work.
• An employee who lives in Pennsylvania, for instance, would not have to pay income tax to more than one state if the company they work for is located in Indiana, Maryland, New Jersey, Ohio, Virginia, or West Virginia. If the company they work for is located in any other state, however, the employee would have to pay income tax to both Pennsylvania and that other state, assuming it imposes state income tax, as some states do not.
• If you must deposit and report state income tax on behalf of an out-of-state employee, you’ll need to apply for a State Tax Identification number, which is the state equivalent of an Employer Identification Number.
• In addition to income tax, payroll taxes include the employees’ and employer’s shares of Social Security and Medicare taxes, also known as FICA taxes, and federal unemployment taxes, known as FUTA taxes and paid by the employer. Created by the Federal Unemployment Tax Act, FUTA taxes are paid to states to help workers who have lost their jobs. Many states collect an additional unemployment tax from employers under the State Unemployment Tax Act (SUTA). If that applies to your out-of-state employee, you’ll need to register for a State Unemployment Tax Act account with their state.

Because laws regarding workers vary from state to state, it’s important to be aware of issues such as workers’ compensation and overtime pay. But there is more to consider.

Below is a list of additional considerations regarding payroll for out-of-state employees:

• Minimum wage – While the federal minimum wage, established under the Fair Labor Standards Act (FLSA), has held steady at $7.25 per hour for the past 15 years, every state can set its own minimum wage. In addition, some cities and counties establish their own minimum wage rates, with those rates taking precedence over federal or state rates. For instance, the minimum wage in Colorado is $14.42 an hour, but Denver has its own rate of $18.29. State minimum wage rates vary significantly. Twenty states maintain the federal wage rate, while in California the rate is set at $16 per hour, $16.28 per hour in Washington, and $17 per hour in Washington, D.C.
• Overtime pay – The FLSA sets rules concerning overtime for non-exempt employees, but some states have their own overtime requirements, which must be followed by employers. Under the FLSA, employers must pay time and a half for any hours over 40 completed in one work week, which is described as seven consecutive 24-hour periods. About half of all states adhere to that rule, but some states base overtime on the number of hours worked within one day. Because employers are generally required to adhere to whichever rules are more beneficial to employees, it’s important to know what is required in the states of your out-of-state employees.
• Frequency of Pay – How often you pay employees also varies from state to state, ranging from weekly, bi-weekly, semi-weekly, or monthly. And some states, such as New York, require certain classes of workers to be paid at different intervals. A manual laborer in New York must be paid every week, while clerical and other workers must be paid at least twice a month. You can make payments more often than what’s required, but paychecks must be distributed at least as often as a particular state requires.
• Workers’ compensation – While most employers are required to pay insurance to cover the expenses of employees who are injured as a result of their work, workers’ compensation laws are set on a state-by-state basis and vary significantly. Certain workers are exempt from workers’ compensation in some states, and in other states, the insurance must be purchased from a state fund. Penalties for not purchasing workers’ compensation insurance when it is required can be severe, including large fines and even jail time, so be sure to research the laws or consult with an attorney or other professional.
• Last paycheck – An employee who quits or is fired must receive a final paycheck within a certain timeframe, including unused vacation time in some instances. This rule also varies among states and certain industries.
• Employee breaks – Federal law doesn’t require employers to provide paid meal breaks, but some states do. You’ll also need to be aware of a state’s requirements regarding rest breaks and nursing mother breaks.
• Direct deposit – Employers are permitted under federal law to mandate that all employees accept direct deposit, but some states have laws stating that employers provide other forms of payment if requested by an employee.

As you can see, payroll requirements include a lot of moving parts, depending on where your employees are working. Taking time to research the laws of each state where you have employees can save you hassles, time, and expense in the long run.

How Hiring Requirements Vary from State-to-State

The way you must hire workers also varies from state to state, meaning it’s something else you’ll need to be aware of if you’re considering hiring out-of-state employees. Various aspects of the hiring process, ranging from how a job is listed to the onboarding process of an employee, may be regulated by state law.

I’m certain that your hiring process adheres to the discrimination laws outlined in the federal Equal Employment Opportunity Commission regulations, but some states, and in some cases cities and counties, have additional laws providing stronger protections. Most state anti-discrimination laws forbid discrimination based on race, religion, national origin, age, disability, and sex, but some states go further than others.

In some states, it’s against the law to ask about an applicant’s criminal history before extending a conditional job offer. Other states regulate when you can request credit reports, what types of background checks can be used, and when drug testing is permitted.

Regulations for after you’ve hired an employee also vary from state to state. Some states require employers to submit certain forms within a specified amount of time after hiring, while others have training requirements you must follow.

Benefits considerations:

• Standard benefits, which include health, dental, and vision insurance, can be provided to employees in any state using a broker who is licensed in the state where your business is registered and headquartered.
• If you offer other, voluntary benefit plans such as life insurance or pet insurance, however, they must be handled by a benefits broker licensed in the state of the employee who will receive them. This, as you read earlier, may include Workers’ Compensation insurance, which is mandatory in every state except for Texas.

Other considerations:

• While there are a lot of legal implications when hiring out-of-state employees, there are some practical ones, as well. How do you bring together employees who work from different locations and may not have physically met one another? How do you create connections between employees and maintain a positive company culture?
• Experts suggest that you create an employee handbook that distributes information and gets everyone on the same page regarding company rules, legal rights of employees, policies, processes, and other topics.
• When scheduling meetings, include any employees who are not physically present where the meeting is held, and make a point to greet and welcome them. Be open about your expectations for all employees, and act in a consistent manner in how you treat your staff, regardless of where they are located.

Conclusion

Hiring out-of-state employees can be advantageous to both employees and employers. Employers get the benefits of a larger pool of talent, expanded uptime with different time zones, employee satisfaction and retention, and in some cases, more competitive wages.

While the benefits are numerous, however, there’s a lot to take into consideration when hiring and managing these workers. Always be sure to research laws particular to the state in which your employee lives, making use of state resources that provide information and contacts, should you need them. If you’re still uncertain about regulations that apply to hiring out-of-state workers, it’s a good idea to check with an attorney or tax advisor to make sure you’re in compliance.