An employee works a few days in another state. A remote worker changes where they perform their job. A bonus is paid this year for services performed last year. For payroll, routine workforce activity like this can quickly become a state tax compliance issue.
As employers approach year-end, work location, compensation sourcing and payroll tax setup are among the details that can determine whether payroll records hold up under state scrutiny.
That is particularly true as employees work across jurisdictional lines, according to Cristina Schrob, a partner at Vialto Partners who leads its U.S. state and local payroll and employment tax practice. Schrob has more than 25 years of employment tax experience, including payroll tax compliance and New York State audit defense.
In an interview with Checkpoint News, Schrob pointed to business travelers, remote and hybrid employees, multi-year compensation, worker classification and payroll-system tax setups as areas employers should be prepared to support during an audit.
New York illustrates the complexity. The state has a limited withholding policy for certain nonresident employees expected to work there for 14 days or fewer, while its separate convenience-of-the-employer rule can affect how wages are sourced when certain employees assigned to New York work outside the state.
For payroll departments, the question isn’t simply whether an audit occurs. It’s whether the employer’s payroll data can explain and support the tax treatment when it does.
State audits keep payroll compliance in focus
Although Schrob has not seen a significant increase in the overall volume of state payroll tax audits, she said compliance remains an important focus for states and employers.
“I would say similar volumes to probably five and 10 years ago,” Schrob said. “Overall states are primarily focused on increasing level of compliance for employers.”
That compliance focus puts payroll at the intersection of several pieces of employee information that may change over time: where an employee lives, where the employee actually performs services, the employee’s assigned work location and how particular compensation was earned.
The challenge becomes more pronounced for a mobile workforce. An employee who travels into another state for a meeting, works from a home in another jurisdiction or receives compensation tied to services over multiple years can present sourcing questions that are not apparent from the payment itself.
“It’s a lot for employers to manage and juggle and track,” Schrob said.
Payroll systems add another dimension because those rules ultimately must be translated into withholding and reporting.
New York business travel can turn days into tax data
New York remains particularly important in the multistate payroll discussion.
New York Tax Law Section 671 generally requires an employer maintaining an office or transacting business in the state to withhold from wages taxable under Article 22. Read New York Tax Law Section 671.
For nonresident employees, New York has an administrative withholding policy that can relieve an employer from withholding on wages paid to certain employees whose primary work location is outside New York and who are expected to work 14 days or fewer in the state during the calendar year. Read New York’s 14-day withholding memorandum, TSB-M-12(5)I.
But a seemingly simple day-count rule can become more complicated in payroll.
Schrob emphasized an important distinction between current-year compensation and compensation attributable to earlier periods. The 14-day policy applies to current-year compensation, she said, but does not provide the same treatment for prior-year compensation such as certain bonuses, equity awards or deferred compensation.
“Those are actually day one withholding compensation elements,” Schrob said.
New York’s own rules demonstrate why compensation sourcing may require payroll to look backward.
For stock options, restricted stock and stock appreciation rights received by nonresidents, New York guidance provides allocation rules when services were performed within New York during the applicable allocation period. The state’s regulations generally determine the New York-source amount by multiplying compensation by a New York workday fraction for the applicable allocation period. Read New York’s stock compensation guidance, TSB-M-07(7)I and 20 NYCRR 132.24.
That can make the history behind an earnings payment just as relevant as the date on which payroll cuts the check.
For employers, Schrob said travel-and-expense information and office badge records are among the records that can help track working days.
New York’s 14-day memorandum also makes expectation important. The state policy specifically concerns employees who are expected to work 14 days or fewer in New York during the calendar year.
Remote work complicates the map
The same work-location problem takes a different form when the employee is not traveling at all.
Hybrid and remote employees can create sourcing questions when an employee’s assigned or primary office is in New York but the person works from a home office outside the state.
New York’s convenience-of-the-employer test provides that an allowance for days worked outside New York generally must arise from services that, from necessity rather than convenience, require out-of-state work. The state’s guidance specifically addresses nonresident and part-year resident employees with an assigned or primary work location in New York who also work from home outside the state. Read New York’s convenience-of-the-employer guidance, TSB-M-06(5)I.
The distinction is significant for payroll because New York also says employers must withhold for nonresidents paid wages for services performed in the state, while employees claiming nonresident status generally use Form IT-2104.1 to certify that status and estimate the percentage of compensation attributable to New York services. See New York withholding requirements.
Schrob said remote and hybrid work therefore deserves attention when employers evaluate payroll compliance, particularly when an employee associated with a New York office is performing work elsewhere.
The broader lesson is that changing where someone works does not necessarily change the tax result in the way an employee or payroll department might initially expect.
Worker classification can become a payroll audit issue in California
In California, one of the issues Schrob said employers should watch is worker classification.
A state examination can move beyond employees already loaded into the payroll system and into the population of workers being treated as independent contractors, she said. Auditors may seek information such as Form 1099 data, contracts, invoices, services performed and the nature of a worker’s relationship with the business.
That scrutiny exists against California’s statutory ABC test.
California Labor Code Section 2775 provides that, for purposes of the Labor Code and Unemployment Insurance Code and applicable wage orders, a person providing labor or services for remuneration is considered an employee rather than an independent contractor unless the hiring entity establishes all three parts of the ABC test. Read California Labor Code Section 2775.
The three requirements are that the worker is free from the hiring entity’s control and direction; performs work outside the usual course of the hiring entity’s business; and is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed. Statutory exceptions can change which test applies.
The test grew from the California Supreme Court’s 2018 decision in Dynamex Operations West, Inc. v. Superior Court, 4 Cal.5th 903, and was incorporated into California law through legislation including AB 5 and later AB 2257. California’s Department of Industrial Relations notes that AB 2257 amended the framework and that Labor Code Sections 2775 through 2787 address worker status. See California’s official independent-contractor guidance.
For payroll professionals, a classification problem can therefore become a tax problem because the starting question is whether the individual should have been treated as an employee in the first place.
Local tax rules add another layer
Schrob also pointed to Ohio as an example of why payroll professionals cannot end their compliance review with state income taxes.
Ohio maintains a statutory municipal income tax framework under Chapter 718 of the Ohio Revised Code. Chapter 718 covers municipal withholding, income subject to tax, an occasional-entrant exemption and specific rules involving remote employees. Review Ohio Revised Code Chapter 718.
The state’s occasional-entrant provisions illustrate how granular the rules can become.
Ohio Revised Code Section 718.011 defines concepts including an employee’s “principal place of work,” fixed locations and worksite locations and contains the state’s occasional-entrant rules. Read Ohio Revised Code Section 718.011.
Meanwhile, Section 718.03 sets out employers’ duty to withhold municipal income tax from qualifying wages, subject to statutory exceptions. Read Ohio’s municipal withholding law.
For payroll, Schrob’s point is practical: the rule on paper ultimately has to be reflected correctly in the system processing the employee’s pay.
A payroll engine configured incorrectly for a state or local jurisdiction can reproduce that problem paycheck after paycheck.
The audit trail starts with payroll’s data
That makes documentation one of the most important themes running through Schrob’s audit-readiness recommendations.
Employers should be able to reconstruct changes to an employee’s residence and work location, she said, and retain the information supporting the withholding treatment that payroll applied.
Travel information can also matter. Expense reports or office access information may help an employer determine where a person was on a particular day, although the presence of a record does not necessarily answer whether the employee actually performed services there.
The distinction becomes particularly important when employers begin using data analytics or artificial intelligence to identify potential payroll discrepancies.
AI, Schrob said, could help compare withholding jurisdictions with residence and work locations or help evaluate information such as expense and office-access records.
But a data point is not necessarily a tax conclusion.
“The human touch is always sort of needed,” Schrob said.
Her example illustrates why. If an employee’s records show travel through New York’s LaGuardia Airport while the employee actually performed work in Connecticut, the travel record alone would not establish that services were performed in New York.
For payroll teams experimenting with automated compliance reviews, that suggests a division of labor: technology can surface inconsistencies, while payroll and tax professionals evaluate the facts behind them.
Year-end offers a chance to find problems before an auditor does
The approach of year-end gives payroll departments an opportunity to perform some of that review before Forms W-2 are issued.
Schrob said employers should examine short-term business travelers, multi-year compensation, remote and hybrid employees and employee payroll tax setups.
“It’s good practice at year end to review like earnings and deduction code set up and employee payroll tax setups,” Schrob said.
New York itself says employers are required to withhold personal income taxes on wages, salaries, bonuses, commissions and other similar employee income, illustrating why compensation type and configuration should form part of that review. See New York’s employer withholding guidance.
For employers with equity compensation, another review question is whether payroll still has the historical work-location information needed to source income correctly. New York’s stock compensation rules, for example, expressly look to workdays during an allocation period rather than merely the employee’s location when income happens to be recognized.
And for remote workers, employers should consider whether the payroll tax treatment continues to correspond with the employee’s actual arrangement and applicable sourcing rules.
That brings the audit discussion back to seemingly mundane payroll records: an address change, a tax election, an earnings code or a day worked in another jurisdiction.
Individually, each may look like a routine transaction.
Together, they can tell an auditor whether an employer’s payroll tax treatment holds up.
5 key takeaways for payroll
- Maintain work-location history, not just an employee’s current address. Multistate withholding can depend on where services were performed, and compensation such as stock awards may require workday information covering an earlier allocation period. New York’s stock-compensation regulations expressly use a New York workday fraction during the applicable allocation period.
- Don’t automatically apply New York’s 14-day policy to every payment. The official policy covers certain nonresident employees with a primary work location outside New York who are expected to work 14 days or fewer in the state, while Schrob cautioned that prior-year compensation presents a different withholding issue. Read TSB-M-12(5)I.
- Remote does not necessarily mean the wages escape New York sourcing. New York’s convenience-of-the-employer guidance looks to whether out-of-state services are performed from employer necessity rather than employee convenience in circumstances covered by the rule. Read TSB-M-06(5)I.
- Include independent contractors in payroll-related compliance reviews. California Labor Code Section 2775 uses the ABC test and places the burden on the hiring entity to establish all three elements when the test applies.
- Use year-end as a payroll tax control check. Schrob recommends revisiting earnings and deduction codes and employee payroll tax setups, along with business travel, remote work and multi-year compensation, while records are still available to identify potential reporting problems before year-end forms are finalized.
