We first spoke with Karen Snodgrass, CPA, Principal at Cray, Kaiser Ltd. and asked for her insights on the tax implications of hiring workers from out of state.
What tax considerations do employers need to keep in mind when hiring from outside their state?
It really depends on what that individual will be responsible for tackling. There can be some legal protections for the company from a tax standpoint. For example, if you have an employee that is only selling widgets from of a state other than Illinois, you may not be subject to all of the other state’s tax laws. But in general, anytime you hire an employee in another state, you are opening the company up to the tax provisions of that state. That could be anything from unemployment tax to withholding taxes, meaning you will need to withhold the other state’s taxes from the employee’s income. Hiring across the border could also open the business up to filing tax returns in that other state. Our recommendation is before you consider hiring someone in another state, definitely fully understand what your tax exposure will be.
Do the tax laws differ greatly from state to state?
Every state has its own rules, and every state has its own tax rate. For example, if your company is located in New York then you file income tax returns in New York. The New York tax rate is higher than Illinois. It doesn’t mean that you’re necessarily double-taxed, but it does mean less of your income will be taxed in Illinois and more is taxed in New York. Ohio, on the other hand, has different tax laws where only businesses that earn more than a specified amount are subject to tax in Ohio. So yes, tax laws do vary greatly.
I’ve had companies hire an individual in another state and based on that team member’s role, the company is not required to withhold state taxes. Which means that the employee is then responsible for paying in-state taxes on a quarterly basis. In terms of the employer/employee experience, especially in this labor market, telling a new employee their tax burden is increasing is not ideal. This goes against why employers are crossing state lines to attract team members in the first place. Most companies want to make it as easy as possible for their new employees.
Does Illinois have any special agreements with border states with regard to taxes?
The state of Illinois has tax reciprocity with Iowa, Kentucky, Michigan, and Wisconsin.
Are there any major drawbacks from a tax perspective?
It is not necessarily a drawback, especially when finding top talent is a challenge, but you need to be aware that you are exposing your organization to the tax requirements of different states which may add complexity for your tax teams. There are added compliance costs when an organization has team members in multiple states, as well as the possibility of higher taxes in that other state, including higher unemployment taxes or higher business income taxes.
Anything else you would like to share on the subject?
As employers, we all have to think outside the box these days. If there’s talent sitting in another state, you simply have to understand the additional costs associated with hiring that person. Long term, this employee may be a better fit or a higher skill set than someone you can find locally. If so, it may well be worth those costs. It is all about understanding your exposure so you can make that business decision, knowing if those extra dollars are nothing (if hiring in a state with reciprocity), are a few hundred dollars a year or are substantial. As with most things in business, it is being armed with knowledge so you can make a purposeful decision.
Rachel Bossard, Partner at Burke, Warren, MacKay & Serritella, P.C. also shared her knowledge on hiring employees who live in another state from a legal perspective.
From a legal perspective, what are the top three things to consider when hiring out of state?
When hiring an employee who will be working in another state, it is important for the employer to consider:
- Whether it needs to form a corporate entity/apply for a tax ID number in the other state in order to pay payroll taxes
- Whether the employer will need to obtain workers’ compensation insurance and pay for unemployment insurance in the other state
- Whether there are any state-specific employment laws that will apply to the employee in the other state
How different are labor laws from state to state? Any states that are particularly challenging?
Many laws differ from state to state, in particular the laws related to employee family or medical leave and sick time. In addition, state laws can vary regarding restrictive covenants such as non-solicitation and non-competition agreements. California is probably the most challenging state to contend with. For example, in addition to a complex set of leave laws that can vary by municipality, California requires that employers pay overtime to non-exempt employees who work more than eight hours per day, whereas Illinois requires the payment of overtime compensation only in excess of 40 hours per week. Also, it is worth noting that restrictive covenants are unenforceable in California.
What happens when the employer state and employee state have conflicting laws?
In most instances, the employee state will prevail. However, this depends on the state and the particular law.
Does Illinois have any special agreements with border states regarding employment/labor laws?
Illinois has reciprocal agreements with Iowa, Kentucky, Michigan, and Wisconsin. As a result of these agreements, residents of those states who received compensation from Illinois employers, are not required to pay Illinois income tax on this income. This applies only to compensation received from wages, salaries, tips, and commissions.
Are there any major drawbacks from a legal perspective?
It can be complicated to have employees in several different states who may be bound by different laws, which require different employee policies and different employee handbooks or separate addendums for each state.
Anything else that you think is important to note?
While it can appear daunting, employers should not be so overly concerned about employing out-of-state residents that they stifle the needs of the business. Rather, employers should simply be mindful of the potential legal complications and should obtain the assistance needed to comply with the laws. Once compliance has been established, the monitoring necessary to maintain compliance should be minimal.
The key takeaway? Don’t be deterred if you find the perfect candidate and they live beyond the Illinois border. Simply do your homework – with the help of EFBC’s Strategic Partners – and understand the tax exposure for your business as well as the legal implications.