A Guide to Paying Remote Employees and Contractors
Have you ever found yourself scratching your head when paying remote employees? Did anyone ever teach you how to pay an independent contractor properly?
Business owners today are met with a wide range of challenges, but none present a higher risk to your company than your payroll procedures. You need to ensure your payroll process is as efficient and error-free as possible.
Of course, that means understanding the differences between an employee and an independent contractor. Furthermore, you need to understand the different state laws when paying remote employees.
For any new small business owner, this might seem like a lot to learn. While it’s tedious in nature and not the most exciting task you’ll have as a business owner, it’s all the more necessary when keeping your business in good standing -- with customers, employees, the IRS, and the governments.
Luckily, you’ll also have the help of payroll software, which can manage a lot of these state and federal laws for you.
Understanding State Withholding Taxes
When paying remote employees, one of the most common mistakes a business owner makes is assuming you pay state withholding taxes in the state where your business is set up. This is not true.
For the most part, you’re going to be paying state withholding taxes in the state the employee works -- not where you work. That means if your business is set up in Los Angeles, CA and your employee works remotely from Buffalo, New York, then you’ll have to pay state withholding taxes in New York -- for that employee.
You can start to see how this can get messy when you have remote employees working all over the country. It’s also a large reason why most people decide to hire an independent contractor in today’s climate, which leads us to our next point.
Understanding the Two Types of Remote Workers
Remote workers come in two forms these days -- an employee and a contractor. Knowing how to pay contractors properly and paying remote employees correctly are two things every business owner needs to know before hiring anyone.
Let’s take a closer look at each type of remote worker:
- Remote Employee - subject to withholding half of the payroll taxes from their paycheck and paying the other half of payroll taxes yourself.
- Remote Contractor - not subject to any withholding or tax payment because the contractor handles it themselves.
You can see why many businesses today are more attracted to the remote contractors, but that doesn’t mean remote employees don’t come with benefits too.
In fact, each state has different ways of classifying workers, making it your main duty to ensure all workers are classified properly. This is in your best interest and will help you avoid any penalties or fees sent down by the government.
How to Pay Contractors That Work Remotely
When compared to paying remote employees, learning how to pay an independent contractor is far easier and requires less work. This is largely due to not having to pay state withholding taxes, which saves any business owner a massive headache when doing payroll manually.
It should be noted that your business might be subject to paying backup withholding taxes if the remote contractor is working in a non-resident state. This is one of the laws and regulations that varies by state, which is why it’s always important to check each state’s laws when hiring employees.
If you’re paying remote contractors for work they completed, there are generally only two forms of paperwork that need to be managed by the business owner -- the W9 and the Form 1099-MISC.
Let’s take a closer look at each document:
- W-9 - this is a ‘Request for Taxpayer Identification Number and Certification’ and must be filled out before you can pay a remote contractor. It’s what gives you the information needed for the second form we’ll talk about. Backup withholding might be necessary if the wrong identification number is given.
- Form 1099-MISC - this is the form you fill out at the end of the year for tax reasons and must be filled out for any contractor you paid more than $600. It’ll tell the government how much was paid to the contractor so they can keep tabs on all the workers in the United States that owe taxes.
You’ll save a lot of time when doing payroll with independent contractors, but make sure you keep accurate records of both of these forms, as well as any payments made to them, which is essential to maintaining good relationships with the government.
Paying Remote Employees for Their Time
When it comes to hiring and paying remote employees, the level of difficulty is raised. First, you’ll have to determine whether they are an in-state employee or out-of-state employee.
In order to figure that out, you need to understand the difference between the employee’s resident state and non-resident state. The resident state is the state the employee lives in, while the non-resident state is the state the worker commutes to for work but doesn’t live in.
Once you understand the difference, ask yourself two questions:
- Does your remote employee do their work at home or do they have to travel somewhere to complete their work?
- Does your remote employee live in the same state your business is registered or do they live in a different state?
If either of these is unclear, use their W-9 to learn their resident state and don’t be afraid to ask them whether they work from home or not. You’ll want to know this information because you’ll be withholding taxes in the state your employee works, whether that happens to be their resident or non-resident state.
Paying Taxes for In-State Remote Employees
When paying a remote employee that works in the same state you registered your business in, then you’ll have to both withhold taxes from your employee’s check and pay state unemployment insurance in the state your business is registered in.
This makes it easy for a small business owner because you don’t have to deal with any different laws in other states. It should be noted, however, that some local regions require a local income tax to be withheld as well.
There’s only one incidence where things can get tricky and that’s if your employee works in your state, but lives in another state. Normally this would be handled the same way as an in-state employee, but that changes when the two states have a reciprocal agreement with one another.
So, what is a reciprocal agreement?
A reciprocal agreement is something that’s signed between neighboring states. It states that employees working in a neighboring state from their resident state, they can withhold their taxes in their home state instead of their work state.
For example, both Pennsylvania and New Jersey have a reciprocal agreement with each other. Illinois is another state with a reciprocal agreement, but they have it between four states -- Kentucky, Michigan, Iowa, and Wisconsin.
Reciprocal agreements are crucial because it saves the employee from having to file two state returns every year. They’ll be eligible for certain tax credits, but it still makes tax returns extremely frustrating year after year.
If you have the right payroll software, it could help make things easier for both you and the employee when dealing with reciprocal agreements. Some software programs even let you do a courtesy withholding from the employee’s check to avoid surprises down the road.
So, how do you set up reciprocal withholding?
Setting up reciprocal withholding with an employee isn’t a difficult process, don’t worry. First, your employee will be required to fill out a non-residency certificate. This certificate is what notifies the employer and government that the employee is excused from tax withholding in their work state.
The business owner won’t have to do anything with this form, except store it away for record-keeping. Once you store it away, contact your payroll provider and explain to them the situation so they can set up the correct withholding amount in the right state for you.
If your employee doesn’t have a non-residency certificate, they can get one by contacting their state’s tax agency.
Paying Taxes for Out-of-State Remote Employees
When paying and withholding taxes for out-of-state remote employees, the process is much different than in-state employees. It largely requires three steps to complete the process properly -- registering, learning, and taking action.
Let’s take a closer look at each step:
The first step in the process requires you to register your business with your employee’s home state. It’s one of the tedious things you need to do with each employee, even if you have employees scattered across the country.
In some areas, you might have to register your business with the various local tax agencies, labor agencies, and unemployment agencies in the home state. Of course, that’s only if it’s required in that state.
The second step in the process requires you to learn the different pay and labor laws inside your employee’s home state. There is a wide range of laws you need to understand if you want to avoid errors, mistakes, and penalties.
Some of the things you might want to learn include:
- Does the employee’s home state require you to offer worker’s comp insurance?
- Does the employee’s home state require you to give breaks? And do those breaks have to be paid?
- Are there any local income taxes that need to be paid in your employee’s home state?
- What are the state’s requirements for overtime and does it benefit the employee more than federal overtime laws?
- Does the employee’s home state require you to withhold state disability insurance?
- What laws and regulations does the state have regarding delivery of paychecks? What about an employee’s final paycheck?
- How often does your employee’s home state require you to pay them? Do they differ from your own state’s requirements?
- Does your employee’s home state require you to provide the employee with a paystub when sending out paychecks?
- Does your employee’s home state have a minimum wage requirement? What about the local agencies?
Once you can get these questions answered, you’ll have a much better idea of what you need to do when paying your remote employees that are out-of-state. It always helps to write down the answers to these questions in an accessible place so you don’t forget.
3. Take Action
Now that you have the information you need, it’s time to put that information to good use. When it comes time to pay your remote out-of-state employee, you’ll need to ensure you withhold the proper amount of state income taxes.
Not only do you have to withhold these taxes, but you have to file them with the state government and make a payment to avoid penalties. You’ll need to check with each state to make sure you do this frequently enough.
In addition to state income taxes, there are unemployment taxes you need to pay each paycheck. The rates for these taxes will vary by state, but you’ll receive the rates when you register for that state (see step 1).
If you’re looking for an easier way to manage these withholdings and tax payments, the right payroll software can do a majority of the work for you. It’s a large reason why so many businesses are taking advantage of what payroll software has to offer.
When searching for a payroll provider that’s right for you, contact Consultants In-A-Box. We can help you implement the right strategies and solutions to increase the efficiency and accuracy of paying remote employees.
And now that you know how to pay independent contractors correctly, you’ll have a much less stressful time come payday. For a business owner, that means more than you can imagine.
- Jordan VanMaanen