Non-Resident Employee Withholding

HR Resource
February 15, 2013 — 3,525 views  
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Working on tax deductions is one of the most complex problems that payroll managers often face. In an age where most people want to save as much as they can off taxes, tax deductions, in the form of employee withholdings, (from the salary of an employee) need to be handled carefully. Since the laws regarding employee withholding differ between states and must be handled differently among legal residents and non-residents, it can become difficult to manage withholding.

In the case of non-resident employee withholding, factors such as residency, reciprocity agreements, state, and payroll taxes can further complicate the situation. Understanding how these factors affect payroll taxes can help get rid of complications that may arise in the future.

Residency can Affect the Amount of Employee Withholding

Residency is a key factor that can alter the way in which employee withholding will govern an individual’s pay. There are different residency statuses that employees can appear under. These can be citizens, resident aliens, non-resident aliens, immigrants, non-immigrants, and undocumented or illegal aliens. The status of residency must be determined using the Substantial Presence Test (SPT) before taxes can be withheld.

Non-resident employees will pay tax only on their US-source of income. Medicare taxes and social security must not be deducted from the wages of such employees. A tax treaty may allow tax exemption on some parts of the income. Standard deductions will not apply; modified deductions must be made to comply with US laws and International treaties.

Reciprocity Agreements

The salary of non-resident employees is also subject to various applicable reciprocity agreements that are signed between the states in which they reside and work. Reciprocity agreements are signed between states to avoid double taxation of a single income. In such cases, one state will not tax a resident of another state with regard to employee withholding on the compensation received for work. However, other forms of income such as rental income, etc. may be taxed or exempted based on the provisions in reciprocity agreements.  

Non-residents are only taxed in their state of residence if this state has signed a reciprocity agreement with the state where the non-resident is employed. In such a situation, the payroll manager of the non-resident employee will have to withhold the reciprocal state’s tax. If an employee’s payroll taxes that are withheld for the state in which the non-resident is employed, the employee can file a refund. 

State Laws about other Sources of Income

State laws and agreements need to be fully comprehended to understand employee withholding. Even if the states are bound by reciprocity agreements, an employee will have to file a non-resident state tax return in the state of employment and a resident tax return in the state of residence. Also, according to the state law, interest income, winnings form lottery, capital gains, and other non-employment sources of income will be taxed if these are not covered in reciprocity agreements.

Tax obligations must be fully understood to avoid hassles arising from non-payment of taxes. Employee withholding will vary depending on many factors, legal advice, and the services of a tax advisor can help in avoiding complications.

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