As employers continue to explore new ways to use artificial intelligence (“AI”) tools and software to support business operations, state legislatures are also taking notice. Specifically, state legislatures are increasingly scrutinizing employers’ use of AI and automated decision-making tools to set or influence employee compensation, with the goal of curbing potential discriminatory effects resulting from the use of algorithmic pay setting and increasing transparency to employees and applicants regarding the use of such technology.
Recent state legislative activity
Several states, including California, Colorado, Georgia, and Illinois, have introduced bills in 2025 that would require parameters to be placed on AI-driven compensation decisions. Lawmakers in New York and Maryland continued this trend in January 2026, introducing bills containing similar restrictions.
Although these state bills are not all identical, they share common characteristics. First, it similarly defines “automated decision-making systems” to include any system, software, or process used to assist or replace human decision-making, including those that rely on machine learning and AI techniques. In the employment context, these definitions include automated human resources tools and software systems that process data through algorithms using predefined rules to help perform human resources functions. These tools can include anything from basic rules-based systems to advanced technologies powered by generative AI.
Additionally, most of these proposed state laws provide guidance for actions that do not constitute illegal uses of algorithmic wage setting. These exclusions include, for example, if an employer (1) offers individual wages based on data related to the services performed by the worker; (2) Disclose in plain language to employees and applicants whose compensation is affected or determined by these methods how the automated decision-making system is used, including the data considered by the system and how the system considers such data; (3) develop and implement procedures to ensure the accuracy of data considered by automated determination systems in setting wages;
Legal risks associated with AI compensation decisions
Lawmakers supporting these state bills emphasize that unregulated use of AI in compensation decisions by employers can result in discriminatory compensation outcomes. In fact, an employer’s AI-driven compensation decisions may be subject to, and actionable under, a variety of employment laws, including Title VII of the Civil Rights Act, the Americans with Disabilities Act, the Age Discrimination in Employment Act, the Equal Pay Act, and/or applicable state and local laws.
The nature of automated decision-making systems already creates unique legal risks for employers, particularly in situations where they rely on these systems to determine employee compensation. In general, the main challenge employers face when using AI-driven tools is the lack of transparency about how the tools arrive at their conclusions and recommendations. While human decision makers can explain their motivations for reward decisions, it can be difficult and sometimes impossible to discern the reasoning underlying decisions made by a particular AI tool. This leaves employers vulnerable to legal challenges to compensation decisions made by AI tools and software. The scope of potential liability can increase if the process is used to set or influence compensation for a large number of employees or applicants.
Points for employers
At this time, employers must ensure compliance with applicable federal and state laws that have been enacted or are scheduled to take effect in 2026. At a minimum, this includes identifying each AI tool currently used to make employment decisions and evaluating whether those tools are subject to regulation by state or local law. Employers should also establish and implement a comprehensive AI policy that outlines internal procedures for using AI, provides necessary notice to employees and applicants about the use of AI, and requires human oversight of AI recommendations.
Looking forward, employers should actively monitor developments in federal, state, and local laws and agency regulations aimed at governing the use of AI in decisions regarding employee compensation and other terms and conditions of employment. As states move rapidly to establish boundaries for the role of AI in workplace decision-making, employers who proactively audit their AI-related practices and prioritize transparent human involvement in decision-making processes, including compensation decisions, will be better positioned to minimize legal risk and adapt to evolving regulatory requirements.
