Federal Tax Rules for Remote Workers and State Nexus

This guide explains how federal tax obligations for wages and payroll interact with state-level nexus rules that can trigger withholding, income tax filings, sales tax collection, and other state duties. It is written for employees, HR and payroll managers, and small-business owners who need practical steps to stay compliant.

Disclaimer: This article is educational and not legal or tax advice. Rules vary by state and situation; consult a qualified CPA or employment-tax attorney for guidance tailored to your facts. Author has 15 years advising clients on multistate payroll and nexus issues.

Why federal rules and state nexus matter

At the federal level, wages are subject to federal income tax, Social Security and Medicare (FICA) taxes, and federal reporting (Form W-2). These federal obligations follow established IRS rules and don’t change because an employee works remotely from another state. However, state tax obligations—including income tax withholding, unemployment tax, and business tax nexus—are determined by each state’s laws. An employee’s physical presence in a state commonly establishes nexus for the employer, creating new registration and withholding duties for that state (NCSL; Tax Foundation).

Failure to understand and act on state nexus can lead to late-registration penalties, uncollected withholding, unexpected multistate tax returns, and interest or penalties on unpaid tax.

Key federal obligations that still apply to remote workers

• Federal income tax withholding: Employers must withhold federal income tax based on the employee’s Form W-4 and pay that withholding to the IRS as described in IRS Publication 15 (Employer’s Tax Guide) (IRS).
• Social Security and Medicare (FICA): FICA taxes apply to wages regardless of the employee’s state of residence or work location.
• Federal reporting: Employers must report wages and withholdings on federal forms (W-2 for employees; Forms 940/941 for unemployment and employment tax deposits) (IRS).

These federal responsibilities remain consistent; the variable part is which state’s laws apply for state income tax withholding, state unemployment tax (SUTA), and state-level business taxes.

How state nexus is established for remote work

States use multiple tests to determine nexus. For employers with remote employees, the most common nexus triggers are:

• Physical presence: An employee working in the state, even remotely from home, often creates nexus for payroll withholding and corporate income or franchise tax purposes.
• Payroll and employment activity: Hiring, paying, or supervising employees in-state.
• Economic presence and sales thresholds: For sales/use tax nexus (after South Dakota v. Wayfair), states use sales or transaction thresholds; employee presence can also create sales-tax nexus for sellers or service providers.

Each state’s standard differs. For example, some states explicitly state that an employee’s presence—even one remote telecommuter—creates nexus; others set day-count thresholds or use convenience-of-the-employer rules (a few states like New York apply such doctrines for sourcing wages) (Tax Foundation; NCSL).

Practical effects for employers

• Registration: If nexus exists, employers must register with the state tax authority to withhold income taxes and to pay SUTA. Some states require an employer to register as soon as an employee begins working in-state.
• Withholding: Employers are typically responsible for withholding state income tax based on the employee’s work location or residence and for complying with state wage-payment rules. Reciprocal agreements between states (e.g., some neighboring states) can alter withholding obligations for cross-border commuters.
• Unemployment insurance: SUTA liability is usually determined by where the employee performs services and can differ from where the employer is located.
• Corporate and franchise taxes: Employee activity in a state can create corporate income or franchise tax filing obligations if nexus thresholds are met.

Because these outcomes differ by state, employers should assume that placing an employee in a new state may create registration and tax obligations there and act proactively.

Practical effects for employees

• Home-state taxation: Residents generally owe income tax to their state of domicile on all income, including wages from out-of-state employers.
• Nonresident filings: Working in a state where you are not a resident may require nonresident tax returns and withholding there for wages earned in that state.
• Credits for taxes paid: Many states provide a credit for taxes paid to another state to reduce double taxation, but credits and rules vary—residents must check their state’s rules.

Keep records that document where work was performed: timesheets, VPN login locations, travel logs, leases and utility bills, and state tax withholding statements.

Common state rules and gotchas (real-world examples)

• Convenience-of-the-employer rules: New York and a few other states have rules that can source wages to the employer’s location if the employee’s remote work is for the employee’s convenience. That can create surprising tax obligations for employees and employers.
• Day-count thresholds: Some states use a specific number of days worked in-state before nonresident withholding or corporate nexus applies.
• Reciprocal agreements: Several states have reciprocal tax agreements that let cross-border commuters withhold only for their home state—check state revenue sites.

Example (from practice): a client moved to a home in Colorado while remaining employed by an Illinois company. The employer initially continued Illinois withholding only. Colorado requires resident tax on all income; the employee had to file Colorado returns and obtain a refund/adjustment from Illinois for excess withholding. Resolving that required amending withholding and paying state income tax in Colorado.

Steps employers and payroll teams should take now

1. Map workforce locations and likely future moves. Require employees to notify HR in writing before changing their primary work state.
2. Update payroll and withholding systems to support multistate withholding rules and day tracking.
3. Register with state tax agencies proactively when employees begin work in a new state; don’t wait for an audit notice.
4. Consider using a PEO or multistate payroll provider to manage registrations and compliance if you have employees in many states.
5. Maintain written telecommuting agreements that clarify the employee’s primary work location, reimbursement, equipment ownership, and tax implications.
6. Review and document nexus exposure for sales and corporate taxes—employee activity may create economic or physical nexus.

Steps employees should take now

1. Keep a clear record of where you work (location and days) and share location changes with HR.
2. Update your state of residence documents (driver’s license, voter registration) if you move permanently; this helps support state residency claims.
3. Review paystubs for proper state withholding and raise issues with payroll promptly.
4. Ask your employer about withholding and whether they will register in your state; if not, get professional tax advice about estimated payments and filing nonresident returns.

How to reduce risk and avoid double taxation

• Use state credits: If you pay tax to both a work state and your resident state, your resident state may allow a credit for taxes paid to the other state—check your state’s tax code.
• Negotiate withholding: For short-term assignments or travel, it may be possible to limit withholding through written agreements or exemptions; this requires careful coordination with payroll and state guidelines.
• Consult a CPA early: Multistate payroll issues are fact-specific. A CPA can help with withholding elections, nexus analysis, and state registrations.

Resources and authoritative guidance

• IRS — Employment Taxes / Employer’s tax guide (Publication 15) and employment tax pages: https://www.irs.gov/businesses/small-businesses-self-employed/employment-taxes (IRS)
• Tax Foundation – analysis on nexus and telework impacts: https://taxfoundation.org (Tax Foundation)
• National Conference of State Legislatures (NCSL) – resources on state tax responses to remote work: https://www.ncsl.org (NCSL)

Useful internal links

• For state-specific payroll and withholding details, see our guide: How Remote Work Affects State Tax Withholding: https://finhelp.io/glossary/how-remote-work-affects-state-tax-withholding/
• To understand broader state nexus rules and thresholds, read: State Nexus Rules: When Your Business Owes State Taxes: https://finhelp.io/glossary/state-nexus-rules-when-your-business-owes-state-taxes/
• If you anticipate working in multiple states, our multistate filing guide explains common steps: How State Income Tax Withholding Works When You Work in Multiple States: https://finhelp.io/glossary/how-state-income-tax-withholding-works-when-you-work-in-multiple-states/

Final checklist (quick)

• Track days worked by state
• Require written location updates from employees
• Register for withholding and SUTA when an employee establishes work presence
• Use professional payroll services or a PEO if multistate complexity is high
• Keep residency documentation and consult a CPA for filing strategies

Understanding the split between uniform federal payroll rules and variable state nexus tests is essential in the era of remote work. Taking a structured approach—tracking locations, updating payroll systems, registering proactively, and consulting experts—reduces surprises and keeps your business and people compliant.

Author note: I’ve advised dozens of small and mid-sized employers on multistate payroll and nexus since 2010. When in doubt, document, register early, and get state-specific advice.