Because VC backed startups need to hire fast and tend to be pretty lean in the early days, hiring remote employees has become a fast-growing trend. Remotive, a job board for startups, releases a list of startups that hire remotely. In 2016 their list had 200 companies, in 2018 they had 600.
Even though there are companies that are 100% remote, like Automattic and Buffer for example, most startups tend to have a mix of employees who work in the office and remote employees. What I have seen most often is that startups hire technical, sales and client service employees remotely.
If the startup is located in a startup hub, like Silicon Valley or New York City, it can be hard to attract technical talent quickly enough or it may be too expensive to build an early product. That is why they turn to remote employees for technical positions, like software developers and designers. According to glassdoor the average senior software developer salary in San Francisco is $144 thousand. With an average initial round of funding between $700 and $800 thousand, according to CB insights, and high salaries in startup hubs, early stage startups can run out of money pretty quickly.
Sales and client service teams are usually hired remotely to sell to and service clients in specific locations. Sometimes remote employees will rent a desk at a coworking space.
Most startups are moving so fast that they do not have time or even realize that there may be compliance issues with hiring employees based outside of the state(s) and/or country where you do business.
Most people talk about the benefits and challenges of working with a remote team, but leave out the part about compliance. Since there are tax and legal issues involved with hiring remote employees, it can become problematic and costly for startups that do not comply.
US based employees and contractors
When we say US employee, we mean a W-2 employee. This is someone who has been hired by the company and the company withholds and submits payroll taxes on their behalf. The company also follows state and federal employee compliance regulations.
Contractors are any other individuals or a company, usually LLCs, that the startup hires based on a contract and pays them directly without withholding and submitting payroll taxes on their behalf.
A startup can evaluate their compliance needs around remote employees and contractors by first finding out what constitutes doing business in a state. When a state considers a company to be “doing business” in their state, the company may need to pay taxes, charge sales tax or pay business registration feeds. You may have also heard your accountants talk about having “nexus” in a state.
Each state has their own rules for what they consider doing business in their state. If your company has any of the following in a state, you should check the guidelines for that state to see if it would be considered doing business in that state.
- An office (which may include a rented a desk at a coworking space) or store located in that state
- A W-2 employee working from home in that state
- Sales employees that visit the state
- Revenue originating from several customers based in that state
Even though there are more reasons than simply having a remote employee in a state to need to register to do business, we are only going to focus on remote employees here. If your company meets any of the other criteria you should look in to whether or not you need to register to do business.
Foreign based remote employees and contractors
Working with employees and contractors located outside of the US adds another level of complexity to compliance. I have seen many startups hire someone who is based outside of the US and pay them via Paypal or wire transfer.
The problem is that you, the company paying the foreign individual or business, have additional responsibilities and liabilities. If you hire a US tax resident that is based outside of the US, you can treat them like a 1099. But if you hire non-US tax residents based outside of the US there is more work to do.
There are two possible ways to hire a non-US tax resident living outside of the US.
- Work with a local payroll company to pay them like an employee. Here the payroll company will follow local tax and employee regulations to pay this employee. This may or may not be possible depending on the country. Research international payroll companies and the specific country to learn about your options.
- Pay them like a contractor. Here you will need to work with your accountant because each country has a different tax treaty with the US. But in general you will need the non-US tax resident employee to provide you with a W-8Ben form and you will need to withhold and submit 30% to the IRS. Since each country is different, the withholding percentage varies significantly.
If you are a startup in the early stages you probably find compliance onerous and maybe even a waste of time. The truth is that initially, if you do not comply with state and federal laws, probably no one will notice and nothing will happen. It really depends on the state, county or city.
The problem comes, however, when you are trying to close a round of equity or debt funding or get acquired. During the due diligence process the other party’s lawyers may request evidence that you are compliant. I don’t know about you, but I do not want to hold up the deal closing for something that we should have already done. Some states can take weeks or longer to register your business and provide good standing certificates. You may even need to pay penalties and fines for not having registered previously.
Even though compliance for your startup might seem intimidating, it is usually not that difficult. Most states post the information you need on their website and in my experience most states are helpful when you call to ask questions.