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The pandemic-driven normalization of remote work created what many founders believed was a solution to California’s business climate problems: hire great people anywhere, pay their local market rate, and maintain California headquarters for leadership and sales while building teams in lower-cost markets. This strategy is real and it works — partially. What founders often don’t realize is that California has specific tax nexus rules that can pull remote employees’ income into California’s tax system in ways that create unexpected obligations for both the employer and the employee.
California’s Aggressive Nexus Rules
California’s Franchise Tax Board has an expansive view of when income has California source. For individuals, California source income includes compensation for services performed in California, regardless of where the employer is headquartered. For companies, having employees in California — even remote employees working from home — creates California nexus, subjecting the company to California income tax on its California-apportioned income.
This means a Delaware corporation headquartered in Texas that has one remote employee working from their home in San Diego has California nexus — and may owe California franchise tax on the portion of its income attributable to California. The single remote employee created California presence with California consequences.
The Employee Side of the Equation
California taxes income based on where services are performed, not where the employer is located. A California resident who works remotely for a New York employer owes California income tax on all of their compensation — at California’s rates up to 13.3%. The employer must withhold California state income tax regardless of where the company is headquartered. If the employer fails to withhold California taxes, the employee still owes them — and the employer may face penalties for failure to withhold.
This creates a compliance obligation for out-of-state companies that hire California residents: register with California’s Employment Development Department (EDD), set up California payroll tax withholding, and pay California employer payroll taxes on those employees’ wages. Failing to do so doesn’t eliminate the obligation — it just adds penalties when the FTB discovers the gap, which it increasingly does through data matching with federal returns.
The Sourcing Rules for Stock Compensation
Stock options, RSUs, and other equity compensation add another layer of California-specific complexity. California taxes equity compensation based on the portion of the vesting period during which the employee was a California resident. An employee who received stock options while living in California, then moved to Texas, and then exercised the options may owe California income tax on the portion of the gain attributable to the California vesting period — even though they no longer live in California. The FTB is aggressive in asserting this claim, and the amounts at issue can be substantial for employees with significant equity compensation.
The Practical Compliance Framework
For remote-first companies with California employees, the compliance framework is clear: register with the EDD, withhold California taxes, file California payroll tax returns, and file California income or franchise tax returns if you have California nexus. Work with a California-experienced CPA or tax attorney to determine your apportionment formula — the methodology for calculating what share of company income is California-source. Budget for California compliance costs as a line item in your operating plan. Don’t assume that because your company is incorporated elsewhere and your founders live elsewhere, California’s tax system doesn’t apply to your California employees and their compensation.
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