Hiring Remote Workers in Other States: Tax and Payroll Rules

You found the right candidate. They live 3 states away and want to stay there. Hiring them remotely is easy on the human side: send a laptop, set up accounts and schedule a video welcome. The payroll side catches many small businesses off guard.

The short version: in most cases, employment rules follow where the employee physically works, not where your company is based. That means a single remote hire in a new state can trigger new registrations, new tax accounts and a new set of labor laws. This guide explains what changes, in plain terms, so you can plan before the offer letter goes out.

This is not legal or tax advice. State rules differ and change often, so confirm details with each state agency, your payroll provider or an employment attorney.

The core rule: the work location usually decides

For most payroll and labor purposes, the state where your employee performs the work is the state whose rules apply. If your company is in Ohio and your new developer works from home in Colorado, you will generally deal with Colorado for income tax withholding, unemployment insurance and many employment laws.

Federal obligations don’t change. You still withhold federal income tax, Social Security and Medicare, pay federal unemployment tax (FUTA) and complete Form I-9 the same way for every employee, wherever they live. See our guide on how to run payroll for a small business for the federal basics.

What does change is the state layer, which has 5 main pieces.

Step 1: register as an employer in the new state

Before the first paycheck, you’ll usually need accounts with 2 agencies in the employee’s state:

• The state tax or revenue department, for income tax withholding (unless the state has no wage income tax).
• The state workforce or labor agency, for unemployment insurance.

Registration is usually online and can take anywhere from a few minutes to several weeks to receive account numbers, so start as soon as the offer is accepted.

Having an employee in a state can also mean your company is “doing business” there. Depending on the state, that can require registering your business with the Secretary of State (often called foreign qualification) and can create exposure to state income or franchise taxes. It may also affect sales tax nexus if you sell products. Ask your accountant whether 1 remote employee triggers these obligations in your specific case.

Step 2: withhold the right state income tax

In general, you withhold income tax for the state where the employee works. A few situations change that.

States without wage income tax. A handful of states, including Texas, Florida, Washington, Nevada and Tennessee, don’t tax wages. If your employee lives and works in one of them, there’s no state income tax to withhold, but you still have unemployment insurance and labor law obligations.

Reciprocal agreements. Some neighboring states agree that residents who cross the border to work only pay tax to their home state. Pennsylvania, for example, lists reciprocal agreements with Indiana, Maryland, New Jersey, Ohio, Virginia and West Virginia. An employee from one of those states working in Pennsylvania files form REV-419 with the employer, and the employer withholds the home state’s tax instead.

“Convenience of the employer” rules. A few states can tax remote workers who live elsewhere if their main office is in that state. New York is the best-known example. Its nonresident tax guidance says days telecommuting are treated as days worked in New York unless the employer has established a bona fide employer office at the telecommuting location. If your employee is assigned to a New York office but works from another state, you may need to withhold for New York, and the employee may need to claim a credit in their home state.

Local income taxes. Some cities, counties and school districts levy their own payroll or income taxes, notably in parts of Ohio, Pennsylvania, Maryland, Michigan and New York City. Your payroll system needs the employee’s exact address to get these right.

Key takeaway: Assume the employee’s work state controls payroll taxes, then check 3 exceptions: no-income-tax states, reciprocal agreements and convenience-of-the-employer rules.

Step 3: pay unemployment insurance in the right state

Unemployment insurance works differently from income tax. Each employee’s wages are reported to just 1 state, so the employer isn’t taxed twice and the worker has clear benefit rights.

States use a standard set of 4 tests, applied in order and described in the US Department of Labor’s guidance on localization of work:

1. Localization: Is all the work done in 1 state, or is the work elsewhere only temporary or incidental? If so, that state covers it.
2. Base of operations: If not, is there a fixed place the employee starts from and returns to, where some work is done?
3. Place of direction and control: If not, is the work directed from a state where some of the work happens?
4. Residence: If none of the above settle it, the state where the employee lives covers the work, if some work happens there.

For a fully remote employee who works from home in 1 state, the answer is almost always that state. New employers in a state usually pay a standard new-employer rate until they build a claims history.

Step 4: report the new hire

Federal law requires every employer to report newly hired and rehired employees to a state directory of new hires, generally within 20 days of hire, though some states set shorter deadlines. Employers with workers in several states may be able to choose 1 state to report all new hires, but they must notify the federal Office of Child Support Services of that choice. Your payroll provider usually handles this automatically.

Step 5: follow the employee’s state labor laws

This is where many small businesses slip. Once you employ someone in a state, that state’s employment laws usually protect them, even if your company is based elsewhere. Common differences include:

• Minimum wage and overtime. Many states and cities set minimum wages above the federal level, and a few have daily overtime rules.
• Paid sick leave. A growing number of states and cities require paid sick time, with different accrual rates and carryover rules.
• Paid family and medical leave. Several states, including California, New York, New Jersey and Washington, run paid leave programs funded partly through payroll contributions you must withhold or pay.
• Final paycheck timing. Some states require final pay on the last day of work, while others allow until the next regular payday.
• Pay frequency and pay stubs. States set minimum pay frequency and what must appear on a pay statement.
• Expense reimbursement. Some states, notably California, require employers to reimburse necessary work expenses, which can include part of a remote worker’s phone or internet bill.
• Pay transparency. A number of states require salary ranges in job postings or on request.
• Required notices and posters. Remote employees still need state-required notices, usually delivered electronically.
• Non-compete rules. Some states sharply limit or ban non-compete agreements.

Also check workers’ compensation. Your policy needs to cover employees in each state where they work. Tell your insurer before the start date.

Your options for handling multistate payroll

Whichever option you choose, keep each employee’s work address current. An employee who moves without telling you can leave you withholding for the wrong state for months. Add a “tell us before you move” rule to your remote work policy and your employee onboarding checklist.

Don’t fix it by calling them a contractor

Some businesses try to avoid multistate registration by paying remote workers as independent contractors. That’s risky. Worker classification depends on how the work is controlled, not on the worker’s location, and states and the IRS can assess back taxes and penalties for misclassification. Our guide to 1099 contractors vs W-2 employees explains the tests.

Where to start: a checklist before your first out-of-state hire

1. Confirm where the employee will actually work, and get their full home address for local taxes.
2. Check the state’s income tax situation: no wage tax, reciprocity or a convenience rule.
3. Register for withholding and unemployment insurance accounts in that state.
4. Ask your accountant about foreign qualification and state business taxes.
5. Update your workers’ compensation policy to include the new state.
6. Review state labor laws on minimum wage, sick leave, paid family leave, final pay and expense reimbursement, and update your offer letter and handbook.
7. Set up the employee in payroll with the correct work state and report the new hire.
8. Add a relocation rule to your policies so employees tell you before they move.

If this is your first hire of any kind, start with our guide on how to hire your first employee.

Conclusion

Hiring remote workers in other states lets a small business recruit from a much bigger talent pool, but each new state brings its own tax accounts, filings and labor rules. The pattern is predictable: register in the employee’s work state, withhold the right income tax, pay unemployment insurance where the work is localized, report the hire and follow that state’s employment laws. A good payroll provider, PEO or employer of record can handle much of the work, as long as you keep employee locations accurate and review the rules before each new state.

Sources

• US Department of Labor, UIPL 291: Localization of work provisions — the 4 tests for assigning unemployment insurance coverage to 1 state
• New York State Department of Taxation and Finance: Nonresident FAQs — telecommuting days treated as New York workdays without a bona fide employer office
• Pennsylvania Department of Revenue: Income subject to withholding — reciprocal agreements with 6 states and form REV-419