Multi-State Payroll

Overview

Managing multi-state payroll presents unique challenges for employers who must navigate tax regulations across different states. Employees working in multiple locations may be subject to varying tax rules related to income tax withholding and unemployment taxes. This article covers the key considerations for handling multi-state payroll, including income tax withholding methods, reciprocity agreements, courtesy withholding, and state unemployment taxes.

Withholding Taxes for Multi-State Employees

When an employee works in more than one state, employers must determine where to withhold taxes. Below are the key concepts employers should understand.

Multi-State Taxation

Multi-state taxation arises when both the work and home states require tax withholding from an employee's wages. In most cases:

• Work State: Non-resident tax is withheld.
• Home State: Resident tax is withheld.

The complexity increases when nexus is established in both states, meaning the employer has a business presence in each state. Employees typically complete withholding forms (state W-4s) for both the work and home states to calculate tax withholding amounts.

OnTheClock’s platform uses "workplaces" as a proxy for nexus, ensuring accurate withholding for employees working across multiple states.

Reciprocity Agreements

Reciprocity agreements simplify tax withholding when employees live and work in different states. These agreements allow employees to have taxes withheld only for their home state.

• Employee Action: Employees must opt into reciprocity by completing a non-resident certificate. This informs the employer to withhold taxes only for the home state.
• States with Reciprocity: Currently, 16 states and Washington, D.C., have reciprocity agreements, easing tax requirements for employees working across state lines

Example 1: Jenny commutes from New Jersey to New York every day for work. There is no office for her company in New Jersey nor is she allowed to work from home. How should withholding be calculated for Jenny?

Because New York and New Jersey do not have a reciprocal agreement in place, the work location will be used for tax calculations and therefore, Jenny will only have New York withholding calculated.

Example 2: Frank commutes from New Jersey to Pennsylvania every day for work. There is no office for his company in New Jersey nor is he allowed to work from home. How should withholding be calculated for Frank?

Because Pennsylvania and New Jersey do have a reciprocal agreement in place, the residential location will be used for tax calculations and therefore, Frank will only have New Jersey withholding calculated.

Courtesy Withholding

As of April 2025, OnTheClock supports Courtesy Withholding through our API.

Courtesy withholding occurs when an employer voluntarily withholds taxes for the employee’s home state, even if not required by law. This often applies when no reciprocity agreement exists, and the employee prefers to have taxes withheld for their home state while temporarily working in another state. For more details, see our guide on Courtesy Withholding.

Unemployment Taxes for Multi-State Employees

In addition to income taxes, employers must also manage State Unemployment Insurance (SUI) or contributions, which provide temporary wage benefits to employees who become unemployed. For employees working in multiple states, determining the correct state for unemployment tax reporting requires applying specific tests established by the U.S. Department of Labor.

The Four Tests for Unemployment Taxes

1. Localization Test
2. Base of Operations Test
3. Many states participate in the Interstate Reciprocal Coverage Agreement, which allows employers to cover services in a single state when an employee works in multiple states.
4. Place of Direction and Control Test