Don't hire remote employees living in California
A few years ago I had an idea for a startup. It was for a cool new software-as-a-service product. It was nothing terribly difficult from a technical perspective, but it had a lot of moving parts. It needed a lot of database work, a ton of connectors, maps, and all kinds of little features.
I got started on it and the work…bogged…down. It was going to take many months, with very uncertain prospects for revenue. I needed help to get it done.
So I put out a message and found a guy. He was living in California at the time, and I'm in Chicago, so we did the remote-hire thing over Zoom. We started with a short-term 1099 contract, and then moved to a full-time W-2 after it was clear that things were going well.
He was really outstanding, by the way. Easy to work with, very reliable, and did great work.
I decided to do the right thing by switching to W-2 payments. Given the remote and mostly unsupervised nature of the work he was doing, we could have (legally) stuck with 1099 payments. But a W-2 an employee gets payments into social security, unemployment insurance, various protections, so it’s the decent thing to do, even if it costs a bit more.
So I set up a payroll service and paid him.
Three years later, I get a letter from the State of California Franchise Tax Board: Demand for Tax Return. Uh, what?
Our records show your business entity received income from, but not limited to, the sources listed below. This information indicates that your business entity may be deriving income from California sources and may have a California filing requirement for 2019.
EMPLOYMENT DEVELOPMENT DEPARTMENT
Wait a minute. I am “deriving income” from a government agency (no, I’m not) and therefore I have to file a California income tax return?
This company never took off, by the way. It had zero customers in California, generating zero revenue. All I had was one employee living in a beach house in California so he could surf.
The mailing included a separate form asking me 30 intrusive questions about my business. They want my financials, both in and out of California. Do I own property? Do I lease or rent? Do I have merchandise? A warehouse? Did I sign any contracts in California? Did I go to a trade show, and if so, list all the locations, number of days and how much money did I spend on goods distributed at each event? It goes on and on.
So now they’ve lied to me about my income and demanded information that is none of their business.
You’d think that I could simply tell them that I’m not doing business in California and be done with it. No — California defines “doing business” in a number of ways, one of which is to have more than 25% of your payroll in California. Which I had, because I had only one employee.
So now, because I employed one of their residents, I’m fully subject to California regulation. I have to file all of the employment-related forms, including those pertaining to withholding and unemployment insurance (which I expected). I also have to register my company with the California Secretary of State and renew my information every year or face penalties, and apparently I have to file a corporate income tax return
You’d think I’d be able to file a simple return, file zeroes on it, and be done with it. But no — I had to pay my accountant to do it, and the form is literally 42 pages long. That cost a few hundred dollars. And in the end, I still owed them $800. For 2019 alone; I’ll also owe them for 2020 and 2021.
I owe $800 for the “minimum franchise tax”. California charges this fee to everyone for the “privilege” of “doing business” in California, whether they have revenue or not. Only a few states have a business franchise tax, and California’s is wildly higher than anywhere else. This is in addition to California’s generally out of control taxes.
Plus, once you’re in California, you can check out any time you like, but you can never leave. My employee moved to Hawaii (in search of better waves), but the State of California is going to be dogging both of us forever unless we file serious amounts of paperwork.
My advice is to stay out of California, and never hire anyone who lives there.
Congress needs to pass a law that says that hiring a remote employee in a particular state does not, by itself, create nexus for sales or corporate income tax purposes. Nexus should only be created in the traditional way: by selling something in the state, or by having a physical office there. Without this law greedy state governments can send companies nasty surprises, as they did to me.
This law should not be controversial. It will eliminate an entire class of unnecessary paperwork.
Congress should pass another law as well. They should enact a uniform way to report and pay sales, income, and franchise tax across all jurisdictions. States, counties and cities would all be allowed to charge whatever tax they want, on whatever categories of goods and services they want, but they would be pushed to use a universal online form to do so. It would be straightforward to enter your sales by jurisdiction in a single place, enter the categories of things you have sold using standard codes, press enter and have your tax obligations taken care of automatically.
This law might be a bit more controversial because it would smell like a federal takeover of state taxes. It isn't, though, and if states can opt out then there shouldn't be a problem.
I have better things to do that deal with idiots in California who think they have the right to impose obligations on my Illinois business. For me, the solution is simple: don't do business in California. I will not hire anyone who lives there, and I'm not going to sell anything there unless it involves a lot of money. It's just not worth the hassle.
It’s also not worth dealing with the arrogance and general jackassery of California state government.
California is run by smart people. They understand that if a resident of Ca is working in Ca, for a company that happens to be in another state, that employee is still employed in Ca and the employer SHOULD abide by Ca taxes and other requirements. Otherwise you simply have a race to the bottom. The race tot he bottom is what we already see when states fight over who is going to give the most financial incentives and tax concessions to corporations interested in doing business in those states. In the end states get fewer jobs than promised and less tax revenues than are beneficial. It's a scam. Don't blame Californians for being too smart for that nonsense.
Thanks for the post. Sorry you had to pay for that lesson. I think it's pretty good advice to not associate with California in any way. It almost always ends in regret. There are plenty, plenty of great developers outside of California.