Using workers in another state creates real tax exposure — for payroll withholding, unemployment insurance, and in California specifically, worker classification. States are actively auditing multi-state employers, and California is among the most aggressive.
The threshold issue is nexus — whether your business has enough of a connection to another state to create a tax obligation there. For payroll purposes, nexus has always been straightforward: if one of your workers performs services in a state, you generally have a withholding and unemployment insurance obligation in that state from day one.
California’s exposure is particularly significant because of AB5, which took effect in January 2020 and established the ABC test as the default standard for worker classification. Under the ABC test, a worker is presumed to be an employee unless the hiring entity can prove all three of the following: the worker is free from the control and direction of the hirer; the worker performs work outside the usual course of the hirer’s business; and the worker is customarily engaged in an independently established trade or business. This is a high bar. Many arrangements that pass muster under the IRS common-law test fail under California law.
The EDD enforces AB5 in the context of payroll and UI taxes. If you paid California workers as independent contractors and the EDD concludes on audit that they should have been classified as employees, you owe back UI, SDI, ETT, and PIT withholding — plus penalties and interest. The EDD can look back three years for regular misclassification cases and longer if it finds fraud. For out-of-state companies with California remote workers, the EDD often issues an audit notice after a worker files for unemployment benefits and the EDD’s investigation reveals the classification issue.
The remote work wave following 2020 created an enormous unresolved compliance problem for multi-state employers. Many companies hired remote workers in California without registering with the EDD, without withholding PIT, and without a clear view of whether those workers’ arrangements met the ABC test. Getting ahead of it — by reviewing your worker agreements, registering where required, and correcting withholding prospectively — is a better position than waiting for a notice.
If you have workers in California or other states and you are not sure about your classification and withholding obligations, book a free 15-minute call or call (619) 378-3138.
