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Handling an Out-of-State Employee

This article is reproduced with permission from Spidell Publishing, Inc.

When an employer has operations in more than one state, he or she must decide to which state to report wages for income and payroll tax purposes. The rules can be confusing, and mistakes can result in costly interest and penalties. A confusing situation might include an employee in one of several situations:

  • The employee works in several states;
  • The employee lives in another state but works in California;
  • The employee lives in California but works in another state; or
  • The employee lives in a different state than where the employer is located (remote employee).

Employment taxes
The first step in the reporting process is to determine whether the employee’s wages are subject to California Unemployment Insurance UI, Employment Training Tax (ETT), and State Disability Insurance (SDI). If some services are performed in California, the Employment Development Department (EDD) recommends that employers apply these tests, in this order:

  1. Localization test: If most of the services are performed in California, with only incidental services performed elsewhere, the services of an employee are subject to California employment taxes;
  2. Base of operations test: If the first test does not apply in any state, the employee’s services are still considered subject to California jurisdiction if some services are performed in California and the individual’s base of operations is in California (the EDD considers the base of operations to be the place of more or less permanent nature from which the employee customarily starts work and returns within the terms of the same contract);
  3. Place of direction and control test: If the first and second tests don’t apply in any state, an employee’s services are considered subject to California jurisdiction if some services are performed in California and the place from which the employer exercises general direction and control over the employee’s services is in California; and
  4. Residence of employee test: If none of the above applies in any state, an employee’s services are considered subject to California taxes if some services are performed in California and the individual’s residence is in California.

These tests only apply if the employee has performed some services in California. When all of an employee’s services are performed in another state and the employee lives in that state, the employer is not required to report the wages in California for UI, ETT, and SDI purposes.

Personal income taxes
Deciding jurisdiction for an employee’s PIT withholding is much easier. Generally, an employee’s wages are taxable to California if the individual works in California or is a California resident.

Employers may not follow these rules
For example, if the employee is not a California resident and she performs no services in California, the wages are not subject to California taxes. However, her employer has classified her as a California employee and is withholding California taxes from her wages.

This is a common scenario because having an employee in another state may create nexus in that state, meaning the employer should register to do business in that state. This means filing and paying any fees and taxes required by that state. Often, this is why employers don’t register — they simply misclassify these employees as California employees.

The employees are then left with three options:

  1. Request that the employer correct the problem and treat them as employees in the proper state;
  2. File in both California and their home state, and rely on the Other State Tax Credit to reduce the double taxation of the income; or
  3. File in the state where the incorrect withholding was taken, show zero income taxable to the state, explain the error and that the employer won’t correct the problem. It is recommended that the employee attach a copy of the other state’s tax return to show that the tax return is filed and reported the income.

For more information about this article, please contact our tax professionals at or toll free at 844.4WINDES (844.494.6337).
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