Paid Family Leave Adds New Complexity to Multistate Work

Best practices for employers to stay compliant with the tax obligations of a hybrid, mobile, or remote workforce include tracking employees’ locations and considering whether movement results in new obligations, while state paid family and medical leave programs add new wrinkles, two attorneys said March 16.

As state income tax withholding is generally based on an employee’s work location, work from home, flexible arrangements, or travel can create withholding obligations in a different state, said Stephen Kenney, an associate at Ogletree Deakins. However, those types of work styles also mean employers can take a “best talent anywhere” approach to hiring, he said.

“With that, you can end up becoming a multistate employer just because you’re interested in pursuing the top talent that’s out there in maybe a different jurisdiction than where your headquarters are located,” Kenney said.

The basic parameters to determine state withholding coverage are where the employee lives and where they work, Kenney said. An employee working remotely is not generally an exception from having to register with a state secretary of state to do business in the state, and registering for withholding with a state tax department may also trigger notices to register for sales tax or corporate income tax, he said.

Exceptions to the general rules include day or dollar limits before an employee becomes subject to withholding, collectively known as de minimis thresholds, Kenney said. However, “the majority of states don’t have a de minimis threshold,” he said. “So in the majority of states, it’s going to be day-one/dollar-one withholding when a nonresident shows up within that state.”

In contrast, every state uses the same four-part test to determine coverage for unemployment insurance, said Mike Mahoney, a shareholder at Ogletree Deakins. The test is based on where an employee regularly works, followed by their base of operations, place of direction and control if the employee also works in that state, and finally residence if an answer cannot be determined from the other factors, he said.

“In practice, I think I’ve gotten to that fourth test maybe two or three times in two decades of practice, so it’s pretty uncommon,” Mahoney said.

Kenney and Mahoney spoke at PayrollOrg’s Capital Summit in Arlington, Virginia.

States that offer other types of insurance such as temporary disability or paid family and medical leave may also follow the four-part test but “it’s not a universal truth,” Mahoney said. Registering with a state for unemployment insurance will also register the employer for temporary disability or paid family leave insurance, as applicable, Kenney said.

States will also have to comply with IRS guidance on the taxability of paid family and medical leave contributions and benefits, Mahoney said. “In my opinion, I don’t think some of the states were quite ready to implement the rules in this space,” he said, which include reporting benefit payments to individuals on Form 1099-G, Certain Government Payments.

The guidance considers an employer pick-up of an employee contribution as wages, Mahoney said. “It’s basically just like any other employer-paid employee taxes,” he said of pick-ups.

Additionally, family leave benefits are considered income but not wages, meaning they do not have any payroll reporting requirements and instead would be reported by the state on Form 1099-G, Mahoney said.

Medical leave benefits are “a little thornier,” Mahoney said, as third-party sick pay rules apply. They can be excluded from wages if they are attributable to an employee’s contribution or an employer pick-up if it was already reported as wages, he said. “The IRS is going to get you coming or going,” Mahoney said. “If you pay tax on the contribution, then you can get the benefit tax-free. If you don’t pay tax on the contribution, or it’s the employer’s contribution, then they want to tax you on the benefit.”

Employers will also have to find out how much in benefits states have paid to employees so that any taxable wages can be reported on Form W-2, Mahoney said. “Some states are on top of it right now, it’s in action. Others are waiting until 2027,” Kenney said. Kenney cited New Jersey’s temporary disability program as one that reports benefits paid through a portal that employers can access.

Fringe Benefits, Best Practice

In order for home office expenses to be excludable as a working condition fringe benefit, the home office must be the employee’s principal place of business, meaning they have an area of their home used exclusively and regularly for work and have no other fixed work location, Mahoney said. The exclusion would not apply to, for example, hybrid workers or those who do not have a specific office in their home, he said.

Exclusion of reimbursements for phone expenses requires a “substantial noncompensatory business purpose,” Mahoney said, such as a need to contact an employee or if they are in a different time zone. The cost must be unlikely to exceed actual expenses and is not a substitute for wages, he said. Mahoney suggested periodically asking for a receipt and reimbursing that amount.

Overall best practices for keeping track of hybrid employees include tracking work locations, which is typically done by the employee even though the employer is ultimately responsible for knowing where employees are, Kenney said. He recommended looking at mobile employees’ travel data and the locations where they earn wages to see if that triggers withholding obligations.

“If you do permit hybrid work arrangements, it will be far easier for you to allocate wages if you have a static arrangement,” Mahoney said. He suggested having employees and managers notify the employer if they relocate or make changes to a hybrid arrangement and that employees ask for permission, not forgiveness.

“You really want them to be asking for permission because your geographic footprint and your registration obligations can be altered if they’re going to ask for forgiveness,” Mahoney said.