Multistate Payroll Withholding Challenges in Today’s Remote Workforce: Key Questions Employers Are Asking

As remote and hybrid work arrangements continue to evolve, payroll compliance has become significantly more complex. Employers must now manage withholding across multiple states, potentially creating new payroll, tax, and unemployment exposures. Knowing where and how to withhold is crucial to avoid penalties and minimize audit risks. Employers can face several challenges when managing multistate payroll withholding for remote employees. As these challenges arise, employers often find themselves asking key questions, including: these challenges arise, employers often find themselves asking key questions, including:

For Remote or Hybrid Employees, Where Does State Withholding Apply?

The starting point is the employee’s physical worksite location. In most states, wages are sourced to where services are actually performed, meaning remote work in another state can trigger withholding obligations there. However, this general rule is often modified by exceptions, thresholds, and special state laws that employers must evaluate carefully.

Do Federal Payroll Rules Change When Employees Work Remotely?

No. Federal income tax withholding and Federal Insurance Contributions Act (FICA) obligations remain unchanged regardless of where an employee works. Employers must continue to follow IRS payroll requirements, including quarterly filings and deposit schedules. While states often follow federal definitions of employment, state withholding rules operate independently and require separate analysis.

What Are Some Exceptions to the Physical Worksite Location Rule?

Several common exceptions that can alter where withholding is required include:

• Reciprocity agreements: Some states, such as New Jersey and Pennsylvania, allow residents to pay tax only to their resident state, even if they work across state lines.
• Convenience of the employer (COE) rules: A few states, such as New York, apply special sourcing rules that treat hybrid work for an employee’s personal convenience as fully occurring in the employer’s state.
• De minimis thresholds: Certain states waive employer-mandated withholding for limited in-state activity based on days worked and wages earned.

Understanding which rules and exceptions apply and when thresholds are crossed is essential to maintaining compliance.

How Does State Unemployment Tax Differ from Income Tax Withholding?

The State Unemployment Tax Act (SUTA) follows a different framework than income tax withholding. Generally, unemployment tax is paid to only one state and is determined by a series of tests that consider where the employee’s work is localized. Employers should not assume unemployment and income tax sourcing will align.

What If an Employee Works in Another State Only Occasionally?

Even limited or intermittent work in another state can create withholding obligations, depending on that state’s rules. Some states allow short-term activity without withholding, while others impose requirements immediately. Employers should monitor employee travel and remote work patterns to avoid unexpected exposure.

What Are the Biggest Compliance Risks Employers Face?

Common risks include failing to register in a state before payroll begins, missing withholding thresholds, paying unemployment tax to the wrong state, and sourcing withholding to an incorrect jurisdiction. States increasingly use payroll audits and data matching to identify noncompliance.

Practical Steps Employers Can Take Now

To manage multistate payroll risk, employers should:

• Track where employees actually perform services
• Review reciprocity agreements and special sourcing rules
• Register and withhold before obligations arise
• Align unemployment tax filings with localization rules
• Maintain documentation supporting remote work arrangements

How a State & Local Tax Provider Can Help

State and Local Tax (SALT) professionals, such as Baker Tilly x Anchin’s SALT team, help employers assess multistate payroll exposure, implement compliant withholding strategies, and defend against payroll audits. As workforce models continue to change, proactive planning is critical to minimizing risk and maintaining compliance.

For more information on multistate payroll compliance and audit risk mitigation, contact Alan Goldenberg, Principal – Tax at Baker Tilly x Anchin, or your Baker Tilly x Anchin Relationship Professional.