How Do I Handle Payroll Taxes for Remote Employees in California?

The landscape of work has fundamentally changed. Remote employees are no longer the exception—they're becoming the standard across industries. For California business owners, this shift brings a complex question that keeps many up at night: how do you handle payroll taxes when your team is scattered across state lines?

Here's the uncomfortable truth most business owners discover too late: getting remote payroll taxes wrong can cost you thousands in penalties, create audit nightmares, and expose your business to multi-state compliance issues you never saw coming. The old playbook of simply running everyone through California payroll no longer works when your graphic designer works from Nevada, your developer lives in Texas, and your operations manager just relocated to Oregon.

This isn't just about checking boxes on forms. It's about understanding which state gets to tax your employees, when you've accidentally created tax nexus in another jurisdiction, and how to avoid becoming one of the businesses that discovers their payroll mistakes during an audit.

The California Employer's Remote Work Reality

California's employment laws are notoriously complex, and the state's tax agencies are among the most aggressive in the nation when it comes to collecting what they believe they're owed. When you add remote employees working from different states into this equation, you're dealing with multiple tax jurisdictions that all want their piece of your payroll.

Most business owners assume that if their company is based in California, they simply withhold California taxes for everyone. This assumption can create significant problems. The reality depends on where your employees physically perform their work, not where your business is located or where you wish the rules were simpler.

For employees who live and work remotely in California, the rules are straightforward—you withhold California state income tax, pay California unemployment insurance, and handle everything through California's Employment Development Department. These employees fall under California's jurisdiction completely because they're physically working within state borders.

The complications multiply when your California-based business employs someone working remotely from another state. These situations require you to understand the tax rules of multiple jurisdictions simultaneously. A software engineer who moved from San Francisco to Austin during the pandemic doesn't suddenly stop creating tax obligations for your business—those obligations simply shift and multiply.

Understanding Multi-State Payroll Tax Obligations

When your employee works remotely from a different state, you typically need to withhold income taxes for the state where they're physically working, not California. This seems simple until you realize it means registering as an employer in each state where you have remote workers, learning that state's withholding requirements, and filing tax returns in multiple jurisdictions.

Each state has its own income tax rates, withholding tables, and filing requirements. Some states have no income tax at all, which initially sounds like a relief until you discover they make up for it with other employment taxes and fees. States like Texas, Florida, and Nevada don't have state income tax, but you still have federal obligations and potential state-specific requirements for unemployment insurance and other programs.

The concept of tax nexus becomes critically important when you have remote employees. Nexus means you've established sufficient connection to a state that it can require you to comply with its tax laws. In many states, having even a single employee working remotely is enough to create nexus, triggering requirements to register, withhold, and remit taxes in that jurisdiction.

California's own rules about who they can tax add another layer of complexity. California uses a source-based taxation system for nonresidents. If someone is a California resident but temporarily works remotely from another state, California generally still wants to tax that income. However, if an employee permanently relocates to another state, their income from work performed in that new state is typically not subject to California tax—but you need clear documentation of that permanent move.

Federal Payroll Tax Requirements for Remote Workers

Regardless of which states are involved, your federal payroll tax obligations remain consistent. You must withhold federal income tax, Social Security tax, and Medicare tax from every employee's paycheck, whether they work in your office or from a beach in Hawaii. The federal government doesn't care where your employees physically work—they care that you're withholding and remitting the correct amounts.

Social Security and Medicare taxes, collectively known as FICA taxes, apply at a combined rate of 15.3 percent of wages up to the Social Security wage base, which is $176,100 for 2025. As the employer, you pay half of this amount and withhold the other half from your employee's paycheck. For Medicare tax specifically, there's no wage cap, and high earners pay an additional 0.9 percent Medicare surtax on wages above certain thresholds.

Federal unemployment tax, or FUTA, requires you to pay tax on the first $7,000 of each employee's wages annually. Unlike FICA taxes, employees don't contribute to FUTA—it's entirely an employer obligation. The standard FUTA rate is six percent, but most employers receive a credit that reduces the effective rate to 0.6 percent if they pay their state unemployment taxes on time.

The IRS requires you to file Form 941 quarterly to report wages paid, federal income tax withheld, and both the employer and employee portions of Social Security and Medicare taxes. You also need to make periodic deposits of these taxes throughout the quarter—not just when you file the form. Missing these deposit deadlines triggers penalties that escalate quickly based on how late your payment arrives.

State-Specific Withholding Challenges

Every state with an income tax has its own withholding certificate similar to the federal W-4 form. When you hire a remote employee in a new state, they need to complete that state's withholding certificate so you know how much state income tax to withhold from their paychecks. Some states have reciprocal agreements with neighboring states that simplify withholding for employees who live in one state but work in another—but these agreements don't help with truly remote work arrangements.

State unemployment insurance, known as SUI or SUTA depending on the state, creates another compliance requirement. Each state has its own unemployment insurance program with different tax rates, wage bases, and reporting requirements. When you have employees working in multiple states, you typically need to pay unemployment insurance to each state where employees are located based on that state's rules and rates.

Some states assess additional payroll taxes beyond income tax and unemployment insurance. California, for instance, has State Disability Insurance and Employment Training Tax that apply to most employers. Other states have their own unique requirements—you need to research each state individually because there's no universal approach that works everywhere.

Local payroll taxes add yet another layer of complexity in certain jurisdictions. Some cities and counties impose their own income taxes or occupational privilege taxes on employees working within their boundaries. If your remote employee works from Philadelphia, Pittsburgh, New York City, or several other municipalities with local taxes, you may need to withhold and remit to those local governments in addition to state and federal authorities.

The Convenience of the Employer Rule

A particularly thorny issue for California employers involves what's known as the "convenience of the employer" rule used by some states. This rule, most notably enforced by New York, Arkansas, Connecticut, Delaware, Nebraska, and Pennsylvania, can require withholding for the employer's state even when an employee works remotely from a different location.

Under this rule, if an employee works remotely for their own convenience rather than because the employer requires it, some states claim the right to tax that employee as if they were working at the employer's location. This creates situations where an employee might owe taxes to two states—the state where they physically work and the state where their employer is located—though most states provide a credit to avoid true double taxation.

California doesn't use the convenience rule to tax nonresidents working for California employers, which is good news for California businesses with remote employees in other states. However, if you're a California-based business and hire someone who lives and works remotely from New York, you need to understand New York's convenience rule because it could affect how you handle withholding for that employee.

These rules create scenarios where an employee might end up filing tax returns in multiple states, claiming credits for taxes paid to other jurisdictions, and navigating complex residency questions. As the employer, you're responsible for withholding correctly according to these rules, which means understanding not just where your employee lives, but also the specific tax laws that might apply to their situation.

California-Specific Considerations

For employees who are California residents but work temporarily in another state, California generally continues to tax their income. California's tax reach extends to residents regardless of where they physically earn their income, though residents can claim a credit for taxes paid to other states to avoid double taxation. This matters because if you have a California resident employee who's working remotely from another state, you may need to withhold for both California and the other state, depending on how long they're gone and whether they've truly established residency elsewhere.

California's Employment Development Department administers unemployment insurance, disability insurance, and several other employment-related programs. When your employees work in California, you must register with the EDD, file quarterly reports, and pay the appropriate taxes. California's unemployment insurance rates vary by employer based on your experience rating, industry, and other factors, with new employers typically assigned a standard rate until they've built enough history for an individual assessment.

The state's Paid Family Leave program, funded through employee payroll deductions, provides partial wage replacement to workers who need time off to care for a seriously ill family member or bond with a new child. While this is technically an employee-paid benefit through the disability insurance withholding, employers must handle the administrative requirements correctly and ensure proper deductions from paychecks.

California also requires specific notices, posters, and documentation for employees. Even if your employees work remotely, they're entitled to receive information about their rights under California labor law, wage statements that meet California's detailed requirements, and proper documentation of their pay rates and working conditions. Remote work doesn't diminish these obligations—it often makes them more complex to fulfill.

Setting Up Multi-State Payroll Compliance

The first step in handling remote employee payroll correctly is registering as an employer in each state where you have workers. This process varies by state but generally involves applying for an employer identification number with the state's revenue department, registering with the unemployment insurance agency, and potentially registering with other state agencies depending on local requirements.

Each state has different deadlines for registration. Some require you to register before you pay your first employee in that state, while others give you a grace period after hiring. Missing these registration deadlines can result in penalties and back taxes, so it's crucial to register proactively when you hire someone in a new state rather than waiting to see if you'll actually owe any taxes.

Choosing the right payroll system becomes essential when you have multi-state operations. Basic payroll software might handle federal taxes and California requirements perfectly well, but start to break down when you add employees in five or six different states, each with their own rules about withholding, unemployment insurance, and tax deposits. You need a system that can handle the complexity without requiring you to manually calculate taxes for each jurisdiction.

Modern payroll providers often include multi-state capability as a standard feature, automatically calculating withholding based on where each employee works and handling the various filing requirements for different states. However, even with good software, someone needs to understand the rules well enough to set up each employee correctly and ensure the system is working as intended. Blindly trusting software without understanding the underlying requirements is a recipe for costly mistakes.

Documentation and Record-Keeping Requirements

Proper documentation becomes even more critical when you have remote employees in multiple states. You need clear records showing where each employee works, when they started working in that location, and whether they're temporarily working remotely or have permanently relocated. These records become essential if you ever face a residency audit or need to demonstrate why you withheld taxes for one state rather than another.

Employee location changes require immediate attention to payroll tax implications. If someone moves from California to Oregon, you can't simply keep running their payroll through California because that's easier. You need to update their location in your payroll system, stop withholding California taxes, start withholding Oregon taxes, and potentially register your business as an Oregon employer if you haven't already. The timing of these changes matters because you're responsible for withholding correctly from the date of the employee's move.

Work-from-anywhere policies that many companies adopted during the pandemic create documentation nightmares if not properly managed. When employees can work from anywhere, you need systems to track where they actually are and update payroll accordingly. Some companies require employees to notify HR before relocating and get approval based on whether the company can support payroll in that location. Others restrict remote work to states where they're already registered as an employer.

Time tracking systems that capture not just hours worked but location of work can help document payroll tax decisions. If an employee works from three different states during a quarter, you need records showing how many work days occurred in each location to properly allocate withholding. This level of detail might seem excessive, but it's exactly what tax authorities want to see if they ever question your withholding decisions.

Common Mistakes and How to Avoid Them

One of the most common mistakes California businesses make is continuing to withhold California taxes for employees who've relocated to other states. This often happens because changing payroll systems mid-year feels complicated, or because the employee asks you to keep withholding California taxes since they plan to move back eventually. However, if someone is working from another state, you generally need to withhold for that state regardless of future plans or what feels convenient.

Another frequent error involves failing to register in new states promptly when hiring remote employees. Business owners sometimes assume they can wait until the end of the quarter or even the end of the year to register in a new state, but most states require registration much sooner. This delay leads to penalties and interest on taxes that weren't paid on time, even if you later catch up.

Misclassifying workers as independent contractors rather than employees creates enormous payroll tax problems that multiply when those workers are remote. If you classify someone as a contractor to avoid the complexity of multi-state payroll, but they're actually an employee under applicable law, you're liable for all the payroll taxes you should have been paying, plus penalties and interest. California uses a strict ABC test for worker classification that's particularly hard for businesses to satisfy when trying to classify workers as independent contractors.

Some businesses attempt to handle multi-state payroll manually rather than investing in proper systems and expertise. They calculate withholding by hand, make tax deposits based on their best understanding of the rules, and file returns using forms they found online. This approach almost always leads to errors because payroll tax rules are too complex and change too frequently for manual processes to keep up. The money saved on systems and professional help gets consumed multiple times over in penalties, corrections, and time spent fixing mistakes.

The Role of Professional Payroll Management

Professional payroll services become practically essential when you have employees in multiple states. A quality payroll provider handles registration in new states, calculates withholding correctly, makes tax deposits on time, and files all the required returns. They stay current on changing tax laws and rates, so you don't need to monitor legislative changes in six different states.

Asnani CPA's outsourced accounting services include comprehensive payroll management that handles the full complexity of multi-state employment. Rather than trying to become an expert in payroll tax law for multiple jurisdictions, you partner with professionals who already have that expertise and the systems to apply it correctly. This approach eliminates the risk of missed deadlines, incorrect withholding, and penalties for non-compliance.

The cost of professional payroll services must be weighed against the true cost of handling payroll incorrectly. A single penalty for late filing in one state can easily exceed what you'd pay for professional help for several months. When you factor in the time your staff spends dealing with payroll issues, researching tax requirements, and fixing mistakes, the economics of outsourcing become even more compelling.

Professional payroll providers also assume some liability for errors made in their processing, giving you protection if something goes wrong despite your best efforts. If your payroll service calculates withholding incorrectly and you end up owing additional taxes as a result, many providers will cover the penalties and interest resulting from their error. This protection isn't available when you handle payroll yourself or use only basic software without professional oversight.

Technology Solutions for Remote Payroll

Modern payroll technology has evolved to handle the complexity of remote workforces, but choosing the right system requires understanding what features actually matter for multi-state compliance. Basic payroll systems might claim to support multiple states but still require significant manual work to set up each employee correctly and ensure taxes are calculated properly. Advanced systems integrate with time tracking, automatically update for tax law changes, and handle the filing requirements for each jurisdiction without manual intervention.

Cloud-based payroll systems offer particular advantages for businesses with remote employees because they allow employees to access their pay stubs, tax forms, and benefits information from anywhere. These systems also facilitate the paperless processing that becomes essential when your team is distributed across multiple locations and states. Employees can update their addresses and withholding information directly in the system, triggering the necessary payroll changes without requiring someone to manually update paper forms.

Integration between your payroll system and accounting software prevents errors that occur when transferring data manually between systems. When payroll flows automatically into your accounting records, you eliminate transcription errors and ensure your financial statements accurately reflect labor costs. This integration becomes even more important when you have employees in multiple states because the tax liabilities can become complex to track manually.

Some businesses use professional employer organizations, or PEOs, to handle employment for remote workers in states where they don't have significant presence. In a PEO arrangement, the PEO becomes the employer of record for tax purposes, handling all payroll taxes, workers' compensation, and other employment obligations in states where you have only one or two employees. This approach can be cost-effective for companies that want to hire remote talent without establishing full payroll operations in numerous states.

Real-World Scenarios and Solutions

Consider a San Francisco-based startup that hired a senior engineer who lives and works from Austin, Texas. The startup initially ran the engineer through California payroll because that's what they knew how to do. Six months later, they discovered Texas has no state income tax, and they shouldn't have been withholding California taxes for someone working entirely from Texas. They needed to register in Texas for unemployment insurance, amend previous quarters of California filings to remove the employee, and potentially deal with the employee's complaint about over-withholding.

A construction company based in the Bay Area expanded operations and hired project managers working remotely from Nevada and Oregon. Each state has different rules for construction industry employers, different unemployment insurance requirements, and different wage and hour laws that affect how payroll must be processed. The company needed to establish payroll operations in three states, track which employees worked on which projects in which states, and ensure they weren't inadvertently creating additional compliance issues by having employees occasionally cross state lines for projects.

A digital marketing agency with its main office in San Jose hired contractors from across the country, classifying them all as independent contractors to avoid payroll complexity. When California's ABC test was applied during an EDD audit, several of these workers were reclassified as employees, creating retroactive payroll tax liability, penalties for failure to withhold, and unemployment insurance assessments going back three years. The agency faced a six-figure unexpected tax bill that threatened the business's viability.

These scenarios illustrate why proactive planning for remote employee payroll matters so much. The cost and complexity of fixing mistakes after the fact far exceeds the investment required to set things up correctly from the beginning.

When to Bring in Expert Help

If you're handling payroll for employees in more than one or two states, professional help becomes essential rather than optional. The complexity multiplies with each additional jurisdiction, and the risk of costly errors increases proportionally. Even if you've successfully managed California payroll for years, adding remote employees in other states introduces entirely new compliance requirements that require specialized knowledge.

Warning signs that your current payroll approach isn't working include receiving notices from state tax agencies about missing or incorrect filings, discovering that you haven't been making required tax deposits in states where you have employees, or realizing you've been withholding for the wrong state. These problems rarely resolve themselves—they typically compound until you're facing significant penalties and back taxes that could have been avoided with proper setup.

Working with a CPA firm that specializes in small business accounting ensures your payroll integrates properly with your overall financial management and tax planning. Payroll isn't an isolated function—it affects your quarterly taxes, annual returns, and overall tax strategy. A comprehensive approach that includes bookkeeping, payroll, and tax planning working together produces better results than trying to piece together different providers for each function.

The cost of professional payroll and accounting help must be viewed as investment in compliance and risk management rather than merely an expense. The penalties for payroll tax mistakes, the time spent fixing problems, and the stress of dealing with multiple state tax agencies all have real costs that often exceed what you'd pay for professional help. When you factor in the strategic tax planning that comes with working with knowledgeable professionals, the return on investment becomes even clearer.

Creating a Sustainable Remote Payroll System

Developing clear policies about remote work and its limitations can prevent many payroll tax complications before they occur. Some companies restrict remote work to states where they're already registered as employers, requiring employees who want to relocate to choose from an approved list of locations. Others adopt a more flexible approach but require advance notice before an employee moves so payroll can be properly set up in the new location.

Employee communication about location changes needs to be explicit and mandatory. Many payroll problems occur because an employee moved states without telling anyone, or mentioned it casually but nobody connected it to payroll implications. Your policies should require written notification of any relocation and clarify that failure to report location changes promptly can result in payroll tax issues that affect the employee's tax returns.

Regular audits of employee locations help catch situations where someone has moved without properly updating their information. Comparing employee addresses in your payroll system against where they're actually working can reveal discrepancies that need correction. Some companies conduct these audits quarterly, while others check annually or when preparing W-2s for the year.

Building a relationship with payroll and tax professionals who understand multi-state compliance gives you resources to consult when questions arise. Rather than trying to research complex payroll tax questions yourself or making decisions based on incomplete information, you have expert guidance available when you need it. This relationship becomes particularly valuable when facing unusual situations like employees who split time between states or work temporarily in new jurisdictions.

The Bottom Line on Remote Employee Payroll

Handling payroll taxes correctly for remote employees isn't optional—it's a fundamental compliance requirement that affects both your business and your employees. Getting it wrong creates tax liabilities, penalties, and administrative burdens that can significantly impact your operations and profitability. The complexity of multi-state payroll means that what worked when all your employees were in California no longer suffices when your team spans multiple states.

The investment in proper systems, professional help, and compliance processes pays for itself many times over by preventing the costly mistakes that plague businesses trying to handle multi-state payroll without adequate support. Asnani CPA's comprehensive approach to accounting, bookkeeping, and payroll eliminates the coordination problems that occur when different providers handle different aspects of your financial operations without communicating with each other.

California businesses with remote employees face enough challenges growing their operations and serving customers without also becoming experts in the payroll tax laws of multiple states. Partnering with professionals who have that expertise built into their services allows you to focus on what you do best while ensuring your payroll obligations are handled correctly, on time, and in full compliance with all applicable laws.

The distributed workforce isn't a temporary trend—it's the new reality of business operations. Companies that build proper systems for handling remote employee payroll now will avoid the scrambling and remediation that awaits businesses that put off dealing with these complexities until they're forced to by penalties, audits, or employee complaints. The question isn't whether to properly handle remote payroll taxes, but how quickly you can get the right systems and support in place.

Need help navigating payroll taxes for your remote team? Contact Asnani CPA for a consultation. We specialize in helping San Francisco Bay Area businesses handle the full complexity of multi-state payroll while keeping you compliant and reducing your overall tax burden.

‍