Tax Talk Thursday: Multi-State Payroll & Withholding — Compliance for Remote Teams

Remote worker conference call

Remote and hybrid work are no longer temporary solutions — they are permanent features of today’s business landscape. For small and mid-sized businesses, this shift has created a new layer of tax and payroll complexity that is often overlooked until a notice arrives from a state tax agency.

If you have employees working remotely in other states — even just one — your business may already have multi-state payroll obligations. Failing to handle these correctly can result in back taxes, penalties, interest, and unexpected compliance exposure.

The Core Issue: Employee Location Drives Payroll Compliance

From a tax and payroll standpoint, what matters most is not where your business is located — it’s where your employee is physically performing their work. Most states treat an employee working from home as creating physical presence nexus for the employer. That single employee can trigger employer registration requirements, state income tax withholding obligations, state unemployment insurance (SUI) liability, workers’ compensation coverage in that state, and compliance with state labor laws (wage & hour, paid leave, etc.). This applies even if the employee moved on their own and even if your business has no office, property, or customers in that state.

Income Tax Withholding: Which State Gets the Tax?

In most cases, employee wages are subject to income tax withholding based on the state where the work is performed, not where the employer is located. This means if your business is in California but your employee works from Texas, there is no state income tax but you may still have SUI and labor law compliance. If your business is in California and your employee works from New York, New York withholding is generally required. If your employee splits time between states, wages may need to be allocated and withheld proportionally. Many employers incorrectly continue withholding for their home state, which can create underwithholding in the work state and overwithholding in the employer state.

Reciprocal Agreements: Limited but Important

Some neighboring states have reciprocal agreements allowing employees to pay income tax only to their state of residence, even if they work in another state. Examples include agreements between Pennsylvania and New Jersey, Illinois and Wisconsin, and Maryland and Virginia. California does not have reciprocal agreements with other states. If reciprocity applies, the employee usually submits a certificate of non-residency, and the employer withholds only for the resident state. Without this form, the employer is generally required to withhold for the work state.

State Unemployment Insurance (SUI): Often Overlooked

Unemployment insurance is governed by localization of work rules, which consider where the work is primarily performed, where the base of operations is located, where direction and control come from, and where the employee resides. In most remote work situations, SUI will be due in the employee’s work-from-home state. This requires registering with that state’s labor agency, paying employer SUI taxes, and filing quarterly wage reports. SUI mistakes are common and frequently discovered during state audits.

Payroll Registration: You Can’t Withhold Until You Register

Before you can legally withhold and remit payroll taxes in a new state, your business typically must register with the state Department of Revenue, register with the state labor or unemployment agency, obtain state employer account numbers, and set up electronic filing and payment systems. Skipping this step and just “withholding anyway” can still result in compliance issues.

Workers’ Compensation & Labor Law Exposure

Multi-state payroll is not just about taxes. Having employees in another state can also trigger workers’ compensation coverage requirements in that state, different minimum wage rules, overtime rules, paid sick leave and paid family leave programs, and state disability insurance programs (such as in California, New Jersey, New York, Rhode Island, and Hawaii). This is where businesses often get caught — payroll may be set up correctly, but labor law compliance is not.

Temporary vs. Permanent Remote Work

Some businesses assume short-term or temporary remote work doesn’t count. This is risky. Many states consider even short-term physical presence enough to create payroll obligations. While enforcement varies, relying on “it’s temporary” is not a safe compliance strategy. If an employee works from another state for more than a brief, documented, business-related trip, payroll registration and compliance may still be required.

Independent Contractors Are Not a Shortcut

Classifying remote workers as independent contractors to avoid multi-state payroll is a high-risk strategy. States aggressively audit worker classification. Misclassification can result in back payroll taxes, back SUI, penalties and interest, wage and hour liability, and workers’ comp exposure. Remote location does not change worker classification rules.

Common Multi-State Payroll Mistakes

From a tax firm perspective, the most common issues include withholding only in the employer’s home state, not registering in the employee’s work state, missing SUI registration and filings, ignoring state paid leave and disability programs, failing to track where employees are actually working, and assuming payroll software automatically handles multi-state compliance.

Best Practices for Remote Team Compliance

To reduce risk, businesses with remote teams should maintain a current list of employee work locations, require employees to notify you before relocating, review state registration requirements before approving remote work, confirm withholding and SUI setup for each state, coordinate payroll, HR, and tax compliance, and periodically review multi-state exposure with a tax professional.

Why This Matters for Growing Businesses

As your team grows, multi-state payroll issues compound quickly. What starts as one remote employee can quickly turn into multi-state exposure across income tax, payroll tax, labor law, and workers’ compensation. Proactive compliance is far less expensive than cleaning up multi-year payroll issues after a state audit or notice.

Remote teams create opportunity — but they also create multi-state payroll and withholding exposure. If you have employees working outside your home state, it’s critical to confirm your payroll setup is compliant before a state agency does it for you. If you have questions about multi-state payroll, remote employees, or registration requirements, reach out to info@mkhstaxgroup.com for guidance.