A single employee working from another state can create payroll tax nexus for your business, which means you have to register with that state, withhold its income tax from the employee’s wages, and pay into its unemployment insurance system. The obligation often attaches before anyone in payroll notices, because the trigger is usually just where a person sits while they work. Getting this wrong exposes the business to back taxes and penalties, and in some cases exposes the people who sign the checks to personal liability.
What Creates Nexus in Another State
Physical presence is the most common trigger. Leasing office space, running a warehouse, or stationing even one employee in a state generally subjects your business to that state’s payroll tax laws. The employee doesn’t have to work in a company facility. Someone working from a spare bedroom establishes the employer’s physical presence in the state where that bedroom sits. For payroll tax purposes, the location of the labor controls, not the address on your corporate charter.
Many states have also adopted economic nexus standards that reach past physical footprint. These rules look at your financial activity in the state, often measured by the total compensation you pay to workers living there. Clear the threshold and the state treats that as enough economic presence to require registration and withholding.
The trigger that catches employers off guard is the quiet one: a current employee relocates. A developer you hired in your headquarters state who moves across the country creates nexus the day they start working from the new location. You now owe that state withholding compliance, and likely unemployment insurance registration, whether or not you intended to do business there. Hiring someone new in a state you’ve never operated in has the same effect from day one.
Which State Gets the Income Tax Withholding
The default rule in nearly every state is that you withhold income tax for the state where the employee physically performs the work. If the employee lives and works in the same state, the analysis stops there. When the two states differ, both can have a claim: the work state because the labor happens there, and the residence state because it taxes its residents on all income.
Most states give their residents a credit for taxes paid to a work state, so the employee isn’t double-taxed on the same dollar. But the employer still has to withhold correctly for both states where required. The work state generally gets first priority, and the residence state picks up the difference. In practice this means maintaining withholding registrations in every state where employees perform services, and potentially in residence states that require separate withholding.
When Short Trips Don’t Trigger Withholding
Not every day of work in another state triggers withholding. A growing number of states apply de minimis rules that exempt short-term nonresident work. The thresholds vary. Some states allow up to 60 days of work before withholding kicks in, while others set the bar as low as 12 to 15 days per calendar year. A handful use dollar-based thresholds instead of day counts, requiring withholding only after a nonresident employee earns above a specified income floor in that state.
The catch: over 20 states have no de minimis threshold at all. They technically require withholding from the first day an employee sets foot in the state for work. For companies whose people travel to client sites, conferences, or project assignments, tracking days across jurisdictions is a real administrative burden. Many employers build internal systems that flag when an employee approaches a state’s threshold, because discovering the overage during an audit costs far more than catching it in advance.
Reciprocal Agreements Between States
About 30 reciprocal agreements exist among roughly 16 states and the District of Columbia. These let employees who live in one state and work in a neighboring state pay income tax only to their home state. The employer withholds for the residence state and skips the work state entirely, which also spares the employee from filing returns in two jurisdictions.
To use the exemption, the employee files a certificate of nonresidence with the employer. Without that certificate on file, the employer is expected to withhold for the work state as usual. These agreements cover wage income only, and they apply only between the specific states that have signed them.
The Convenience-of-the-Employer Trap
A small number of states apply what’s called a “convenience of the employer” rule, and it flips the default withholding logic. Under this rule, if an employee works remotely from another state for their own convenience rather than because the employer requires it, the employer’s state still claims the right to tax those wages. The home-office state doesn’t get priority; the employer’s state does.
The practical result is that an employee working from home across state lines might owe income tax to the employer’s state even though they never set foot there. The employer withholds for its own state unless it can show the remote arrangement exists out of business necessity, not employee preference. Business necessity typically means the employer assigned the worker a task that can only be performed outside the state. Simply letting someone work remotely because they prefer it doesn’t qualify. If you employ remote workers and your business is headquartered in one of these states, this is where a payroll tax advisor earns their fee.
State Unemployment Insurance Is a Separate Registration
Each state runs its own unemployment insurance program funded by employer-paid taxes, commonly called SUTA contributions. When you establish payroll tax nexus in a new state, you register for unemployment insurance separately from income tax withholding. These are distinct obligations with their own rates, wage bases, and filing schedules.
New employers without an experience rating pay a default rate that varies significantly by state. For 2026, those default rates range from about 1.0% to over 4.0% of taxable wages. After a few years of operating and building an experience record, the rate adjusts based on how many former employees have filed claims against your account. Fewer claims mean a lower rate over time.
The taxable wage base per employee also swings widely, from as low as $7,000 to over $78,000 annually. That range means your unemployment cost for the same employee can differ by a factor of ten depending on which state they work in. Wage bases and rates change annually, so multi-state employers update their payroll systems at the start of each year.
Registering Once Nexus Exists
Registration usually involves two separate accounts: one for income tax withholding and one for unemployment insurance. Some states combine them into a single form; others require separate applications through different agencies. In either case, you’ll need your Federal Employer Identification Number, the date you first paid wages in the state, your business structure, and a description of your activities.
Most states offer online registration portals. Electronic submissions can return an account number within a couple of business days in many jurisdictions, while paper filings can take several weeks. Once you have your state employer identification numbers, you can begin filing returns and making deposits on the required schedule, typically quarterly but more frequent for larger payrolls.
Employers expanding into multiple states at once sometimes use a Professional Employer Organization in a co-employment arrangement, where the PEO handles payroll tax filings and deposits on the employer’s behalf. This reduces the risk of missed registrations but doesn’t eliminate the employer’s underlying legal responsibility.
Worker Classification Comes First
Every payroll tax nexus question assumes your workers are correctly classified as employees. If you’re treating someone as an independent contractor when they should be an employee, the nexus analysis is the least of your problems. The IRS evaluates classification using three categories: behavioral control, financial control, and the nature of the relationship.1Internal Revenue Service. Independent Contractor (Self-Employed) or Employee No single factor controls.
When a worker is reclassified as an employee after the fact, the business owes back employment taxes plus penalties. Employers who filed the correct 1099s face lower penalty rates than those who filed nothing. If you’re genuinely uncertain, you or the worker can file Form SS-8 and ask the IRS for a formal determination.2Internal Revenue Service. About Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding
Penalties and Personal Liability
Federal penalties for late payroll tax deposits follow a tiered schedule based on how late the deposit is:
- 1 to 5 days late: 2% of the unpaid deposit
- 6 to 15 days late: 5% of the unpaid deposit
- More than 15 days late: 10% of the unpaid deposit
- More than 10 days after a delinquency notice, or upon notice demanding immediate payment: 15% of the unpaid deposit
These percentages apply to the amount that should have been deposited, not the total payroll.3Office of the Law Revision Counsel. 26 USC 6656 – Failure to Make Deposit of Taxes Interest accrues on top of the penalty from the due date, and the amounts add up quickly when multiple deposit periods pass before anyone catches the problem.
The most serious federal consequence is personal liability through the Trust Fund Recovery Penalty. Payroll taxes withheld from employees, including federal income tax and the employee’s share of FICA, are considered trust fund taxes because the employer holds them in trust for the government. Any person responsible for collecting and paying over these taxes who willfully fails to do so can be held personally liable for the full amount.4Office of the Law Revision Counsel. 26 USC 6672 – Failure to Collect and Pay Over Tax, or Attempt to Evade or Defeat Tax “Responsible person” isn’t limited to the business owner. It can include officers, directors, or payroll managers who had the authority to direct payment.5Internal Revenue Service. Trust Fund Recovery Penalty Overview and Authority The penalty equals 100% of the unpaid trust fund taxes, assessed against you individually.
States impose their own penalties for failure to register, withhold, or remit, and these vary by jurisdiction. Many states assess late filing penalties, interest on unpaid balances, and can revoke business licenses for chronic noncompliance.
If You’re Already Behind: Voluntary Disclosure
If you discover you should have been withholding and remitting payroll taxes in a state where you never registered, a voluntary disclosure agreement is usually the least painful path to compliance. Most states offer these programs. You come forward, disclose the liability, and pay the taxes owed for a defined lookback period. In return, the state typically waives penalties and limits the lookback to three or four years instead of the full period of noncompliance. Interest on the unpaid taxes is usually still assessed in full.
The critical requirement is that you come forward before the state contacts you. Once a state sends a nexus questionnaire or opens an audit, the voluntary disclosure option generally closes. Employers who discover nexus issues during internal reviews or when onboarding a new payroll system should contact the relevant state before the state discovers them.
At the federal level, the IRS runs a similar program for employers who have willfully failed to comply with employment tax obligations. A voluntary disclosure doesn’t guarantee immunity from prosecution, but it significantly reduces the risk.6Internal Revenue Service. IRS Criminal Investigation Voluntary Disclosure Practice To qualify, the disclosure must be truthful, timely, and complete, and you must agree to pay all taxes, interest, and applicable penalties in full. Timely means before the IRS has started an examination, received a tip from a third party, or picked up information about your noncompliance through a criminal enforcement action.