How State Payroll Taxes Apply to Mobile Employees

Let’s assume your company has an employee who was a resident of California, received a grant of restricted stock units (RSU), and moved to New Jersey before the RSU vested and the shares were released. In addition to determining California and New Jersey state income tax withholding, the company would also have to consider the application of disability insurance, unemployment insurance, workforce development, and family leave insurance on the RSU income.

Historically, only California, New Jersey, and a handful of other states have required such deductions. Recently there has been a substantial increase in the number of states that have introduced state level payroll taxes.

Many states have introduced family and/or medical leave insurance programs; employers are required to withhold premiums from earned income to fund those programs. The number of states with such programs is approximately 20 at the time of writing with several more states planning to implement similar programs in the next few years.

Some states have introduced other taxes to provide funds for specific concerns, e.g., the Transit Tax in Oregon funds public transportation services; Washington CARES funds long-term care for Washington state residents.

While there is a large range of such state programs, for ease of reference in this blog entry, I will refer to them as state payroll taxes. Most state payroll taxes require payroll withholding based on a percentage of income that includes equity compensation. Some state payroll taxes have an earned income limit.

State Payroll Taxes and Mobile Employees

Where mobile employees are concerned, the sourcing rules and liability to taxation may differ between income tax and state payroll taxes.

Most state payroll taxes are based on the state unemployment insurance code (SUTA laws). All states have implemented these, and they are largely uniform. An employee is only liable for SUTA in one state based on standardized tests; for a discussion of these tests and how they are applied, see the article "State Mobility Issues for Equity Compensation Professionals."

Therefore, where the employee is covered by another state’s SUTA, there is no trailing tax liability for SUTA or any related state payroll taxes to a former state. Conversely, state payroll taxes generally have a trailing tax liability where the employee has moved overseas and is not covered by SUTA in another state.

Some payroll systems have system limitations, such as requiring the application of state payroll taxes on any income subject to state income tax. Therefore, some companies are forced to collect state payroll taxes for a former state where the employee is no longer resident.

Not all state payroll taxes are based on SUTA; for example, the Oregon Transit Tax has no earnings caps and applies to both residents and nonresidents. Each state payroll tax needs to be reviewed to determine how the mobility rules apply.

State payroll taxes are typically small (usually less than 1%) and, as noted above, many are subject to an earnings cap. Therefore, some companies may not collect these through the stock administration system. However, where there is no earnings cap or the employee’s income has not yet reached that cap, the payroll system will have to collect the shortfall. Therefore, regardless of whether stock administration collects these taxes, it is important that the company address the application of these taxes to equity compensation for mobile employees.