As the COVID pandemic rages on, employees required to work remotely since March 2020 will continue to do so for at least a foreseeable portion of 2021. While a burden for some, the pandemic has opened endless relocation possibilities for others, allowing some remote workers to visit and stay with family, work from a vacation destination, or work from less expensive areas to save on the cost of living. As we enter a new tax year under COVID, many employers are asking whether they have special obligations to out-of-state teleworkers. In addition, employees who have enjoyed the advantages of their new location may be asking to make the arrangement permanent.
Before acquiescing to the permanent relocation of your employees, employers should be aware of complications related to the employment of out-of-state workers.
How Do Payroll Taxes Change When My Employee Works Remotely Outside of California?
California employers must understand and comply with their payroll tax obligations for out-of-state workers, including the following:
State Personal Income Tax
Each state has its own laws regarding taxation of remote work when an employee works in a state other than where their worksite is located, or a state other than their primary residence. Employees of California employers who work outside of California may have new state and local tax obligations, and California employers may be required to withhold state income taxes for the state from which remote workers live and perform their job duties.
An employer is required to withhold state income tax from wages for an employee’s state of residence if the employer has a business nexus in the state. An employee working remotely from their state of residence on a temporary basis may be sufficient to create a business nexus.
California employers are required to withhold income tax when a California resident performs services that are subject to state income tax withholding laws of both California and another state. However, states are prohibited from double taxation of the same income. To comply with multistate tax obligations in such cases, the employer must make the withholding required by the other jurisdiction, and for California, in the amount by which the California withholding amount exceeds the withholding amount for the other jurisdiction. If the withholding amount for the other jurisdiction is equal to, or greater than, the withholding amount for California, no additional withholding for California is required.
For non-residents, a California employer must withhold California personal income tax and report wages paid to nonresident employees for services performed within California. However, only the wages earned in California are subject to California state income tax.
During the COVID-19 pandemic, some state tax agencies, including the California State Franchise Tax Board, have waived the business nexus during the emergency if established only by the presence of resident employees working temporarily from home due to the pandemic. Employers should verify whether any similar waiver is in place for the “home” state of its employees when determining state income tax withholding.
Unless two states have a reciprocity agreement (which allow residents to pay tax only based on where they live, and not where they work), an employee may be required to file multiple returns to ensure proper taxation. California does not have reciprocal tax agreements with other states.
Proposed legislation, such as the Remote and Mobile Worker Relief Act and the Multi-State Worker Tax Fairness Act of 2020, have been previously introduced to Congress in order to create a uniform approach to taxation for multi-state workers. However, these bills have failed to gain any momentum. Until clarifying legislation is adopted, remote workers who work out-of-state from their employer may continue to face multiple reporting and filing obligations in different states, and create additional administrative obligations for the employer.
Other Payroll Taxes
In regard to other employment taxes, when an employee works in California as well as one or more other states, the state that has jurisdiction for coverage of that employee’s services is determined by the application of four tests. The tests are used by all states to determine where a multistate employee’s wages should be reported and subject to state employment taxes. Jurisdiction is determined (1) by the location of the employee’s service, (2) the employee’s “base of operations” from which the employee starts work and receives employer instructions, (3) the place from which the employer exercises basic and general direction and control, and/or (4) the residence of the employee. An employee must perform some service in California before the tests can be applied to determine whether all the employee’s services can be allocated to California. If California is determined to have jurisdiction over the employee’s services, California must be paid Unemployment Insurance (UI), Employment Training Tax (ETT), and State Disability Insurance (SDI).
The stakes of accurate determination of state jurisdiction can be high. Nine states throughout the country now have paid family and medical leave (PFML) insurance programs similar to California’s SDI/Paid Family Leave (PFL), funded by mandatory payroll taxes. Failure to accurately apply jurisdictional tests can result in added payroll taxes for employees, or ineligibility of employees for PFML. Failure to comply can also result in penalties for employers.
Workers Compensation Insurance
Every employer in California is required to either obtain workers’ compensation insurance, or to secure a certificate of consent to self-insure from the Director of Industrial Relations. For out-of-state workers, the state laws of their state of residence may also apply. If an employee files a workers compensation claim in another state for a California employer, the insurance coverage of the California employer may or may not cover the claim. In addition, other factors such as the length of temporary and permanent disability benefits will likely differ state to state. Employers will need to obtain workers compensation insurance coverage, or a comparable certificate of self-insurance, in the state where the remote worker is located and is performing service. Failure to provide adequate workers’ compensation coverage may result in penalties for the employer.
What Other State Laws Apply To My Employee Who Works Remotely Outside of California?
Wage and Hour and Leave Laws
Most employers are required to comply with the federal Fair Labor Standards Act (FLSA), as well as applicable state wage and hour laws. California public agencies are exempt from a number of Labor Code provisions and significant portions of Industrial Welfare Commission Wage Orders. California wage and hour laws apply to workers who perform all or most of their work in the state, or if a worker does not perform the majority of their work in any one state, California wage and hour laws apply if California serves as the base for work operations.
While California employers are already subject to a vast array of leave laws such as mandatory paid sick leave, other states may be more generous with certain leave laws. California employers with remote out-of-state workers must learn and comply with the overtime, meal and rest breaks, leaves of absence, and other labor laws of the state where the employee performs most of their work.
An employer is required to post mandated state and federal employment law notices in an area frequented by all employees. Failure to display the correct state and federal employment law notices can result in penalties. An employer with out-of-state remote workers must ensure that such workers are on notice of the applicable state laws for the state in which they are working. For such employees, employers can mail or email postings or post them on an employer intranet page.
Are Independent Contractors the Solution?
Recent California legislation has significantly limited the ability to classify employees as contractors, albeit with numerous occupations exempted. To be considered a contractor under California law for the purpose of the California Labor Code (including Workers Compensation), Unemployment Insurance, and California Wage Order compliance, the individual must satisfy the “ABC” test, or belong to one of the state’s exempted professions and meet different requirements. Under the ABC test, in order to qualify as an independent contractor, an individual must (A) be free from the control and direction of the hiring entity in connection with the performance of the work; (B) perform work that is outside the usual course of the hiring entity’s business; and (C) be customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity. The law applies to workers in California, but does not necessarily change how out-of-state workers are classified.
While out-of-state contractors who can qualify as independent contractors under applicable law may provide some solutions, general law cities and counties with civil service systems are subject to other restrictions on contracting out services. California employers should seek legal advice before converting employees to out-of-state contractors.
Other Considerations for Out-of-State Remote Workers
Performance management of remote workers can sometimes be challenging, especially when it is unclear how much time the employee is actually working. When remote workers reside locally (and pandemic rules do not apply), an employer can rescind the telework arrangement and require the employee to work in the office to ensure productivity standards. However, if the employee has relocated out-of-state, the arrangement cannot be so easily undone. Employers should ensure that they have the means to manage the performance of out-of-state employees before agreeing to such an arrangement.
Disaster Service Response
For local government agencies, public employees take an oath and are required to act as Disaster Service Workers (DSWs) in the event of a disaster or emergency. An out-of-state worker will either be required to return to the state to perform DSW duties or be able to perform such duties remotely. Local government employers should consider this when deciding to allow permanent out-of-state telecommuting.
Information Technology Requirements
Employers should explicitly detail the information technology obligations of the remote employee, such as providing a sufficient Wi-Fi connection and virus protection for employee-owned devices.
Employers are encouraged to adopt a formal telecommuting policy that outlines the employer’s expectations for employees who work from home. Rather than a “don’t ask don’t tell” approach, employer policies should clearly outline the employer’s stance on out-of-state telecommuting. A telecommuting agreement with each individual employee can also help to clearly lay out expectations, such as whether the employee is required to periodically appear to work in person and how frequently. Employers should remember to negotiate with its labor unions the impacts of such a policy on terms and conditions of employment. For more information about post-pandemic teleworking, see “Working from Home in a Post-Pandemic World” by Danny Yoo.