Should your company reduce salaries when an employee moves to a lower cost geography?

Due to the sudden explosion of remote work, companies are quite commonly asking us if they should reduce the salaries of employees that move to a geography with a lower cost of living.

In fact, even AT Kruze Consulting we are seeing our own employees leaving San Francisco and moving to less expensive locations. Everyone wants to take advantage of the flexibility that work from home provides - and some of them are having pretty amazing adventures, while still getting their work done. 

There’s a lot of headaches that come with an employee working remotely and moving to a new geography - and one of them is knowing if your employees are being compensated correctly. If they move to a low cost area, should you reduce their salary? 

The first determinant I would make is whether this is a temporary move for that employee, or whether it’s permanent. If it’s temporary, you’re in really good shape, I wouldn’t recommend doing anything, I would just leave it alone. 

Now if it’s permanent, that’s a much bigger deal because a lot of these employees, when they move to that lower cost geography, also want to pay lower payroll tax rates. That’s because they are likely moving from a higher tax state like California or New York, to a lower tax state. And so we’ll get into payroll tax rates in a second, but that necessitates actually making a permanent adjustment in the payroll system, and also registering to do business in that state, pay payroll taxes, there’s a lot of like work for the company. And it’s not free to have to file extra corporate tax returns for new states, deal with sales tax issues, etc. 

Now in terms of what to pay those employees, we are seeing a few companies make those adjustments. They’re actually reducing it based on the standard of living in that geography. Now my advice if you’re going to do that is to clearly communicate this with the employees as soon as possible. You do not want employees going to low cost states, signing a big lease (or purchasing an expensive house) because they think they are keeping the same salary level. That’s a really bad situation for the employees. 

The other thing to remember is that you’re opening yourself up for your employees to be poached. Any time you take something away from people, that always leaves a big, a bad taste in their mouths. So that’s why the clear communication is so important - especially if you can make this policy clear BEFORE anyone asks if they can move. 

I also recommend having a data-centric approach. Now a lot of real estate firms have data on cost of living across the country. There’s also some compensation firms like Radford, even your friendly accountant at Kruze Consulting, or your top law firm for your startup will have some data and possibly help you. One of the of rules of thumb that I’m seeing is like you take high-cost geographies like New York and San Francisco as 100% of salary. And then if you move to other kind of still expensive, but not as expensive cities like Austin, or Seattle, or Boston, maybe you pay 90% of the original salary. And then if it’s a lower cost thing like Boise, or places in you know, Wyoming, or the Southeast, then it’s maybe 85% of typical salary. Those are what people are using as adjustments. However, there’s no real right answer for those adjustment levels. I think the best thing you can do is use a data-centric approach and communicate clearly. 

And again, you really do have to think about the ramifications. If you’re cutting people’s salary, what will happen you know, three months from now, or six months from now if they get a job offer from a startup or a big company that doesn’t really care where they live and just wants them to execute on the job and provide value? So personally, I would not make salary adjustments, especially in the middle of COVID when there’s so much uncertainty, and people’s anxiety levels are really, really high. I think you’re kind of just tempting fate a little too much for my liking. And again, replacing an employee is just so expensive, and it just really hurts the organization. So be careful what you do here. 

Now just a quick aside, if you do make this a permanent change in the employee’s tax status in a state, you do need to register to do business in that state, you need to register to do payroll taxes, and you’re going to have to do some other stuff like worry about sales tax. You’re going to need a quick tax nexus study. And you’re going to have to file federal and state income tax returns, you’re going to have to start including that state. So just know that you know, if people are moving all throughout the country, your tax footprint may really increase. I do know some companies that are limiting the states that people can actually move to and still stay employed. 

At Kruze, we’re not doing that. We’re letting people move wherever they want. But that’s just another thing to consider. We’ll soon be releasing some information to help companies understand the tax nexus ramification of remote workers. So check that out on our Kruze video library. So again, if you’re going to make a salary reduction based on a geography and a lower cost of living, communicate very clearly, make sure you are using data to make that change, and also really think twice about it because you may be opening yourself up for some of your employees to get poached. We also have a number of resources that calculate the average startup founder salary, CEO salary and CTO salary. The CEO one even has a calculator that you can use to estimate pay based on how much funding and which industry your company is in.