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Nomads Can Make You Go Mad – Tax Insights for Remote Workers
Many business entities quickly established work-from-home (WFH) policies in response to COVID-19 restrictions. While these were implemented as temporary stopgap measures, here we are nine months later, ready to welcome in 2021 with no clear prognosis for any short-term change to our working situations. Due to the success and favorable reception of these WFH policies, many companies are now considering transitioning to them as a new permanent “office” standard. Pandemic-related complications from remote employees have the potential to create a madding trifecta of state tax issues: nexus exposure, payroll withholding, and individual income tax filing requirements.
Nexus is the term used to describe the connection a taxpayer has with a jurisdiction that creates taxable presence. In short, nexus is the requirement that must be met before the taxpayer files a tax return. In the wake of the COVID-19 restrictions, taxpayers may be creating nexus for a variety of business taxes (namely corporate income tax, sales tax, and/or property tax) based on employees who work remotely in a jurisdiction where the employer previously had no connection. A limited volume of employees (and any associated taxpayer-owned property) present in a taxing jurisdiction generates sufficient physical presence to trigger business tax nexus in about 75 percent of states. Fortunately, some of these states have provided a temporary income tax nexus waiver for remote workers due to the pandemic. These states include Alabama, California, District of Columbia, Georgia, Iowa, Maine, Massachusetts, Minnesota, New Jersey, North Dakota, Oregon, Pennsylvania, Rhode Island, and Wisconsin. In the absence of an affirmative waiver from a state’s application of its nexus provisions due to remote employees, businesses should assume an unchanged nexus standard and carefully examine the possibility of new tax filing obligations.
Taxpayers also must be concerned with withholding tax issues arising from remote employees. The resident state (home state) of an employee typically has general jurisdiction over the entire amount of an individual’s income from whatever source derived. Double taxation is typically mitigated by a credit for taxes paid on income earned outside the home state and taxed by the nonresident state(s). Withholding tax from employment income is, however, typically based on the location where employees actually work. When the resident state and employment state are the same, the withholding rules are therefore relatively simple to apply. However, when these do not align, other factors must be considered. First, many neighboring states enter into specific reciprocal agreements where the resident state tax rules and withholding apply, instead of the work state rules. Next, if an employee is working in a state other than their home state or their principal work state and they reach that state’s threshold number of workdays, then the state’s withholding requirements are generally activated. Arkansas, Connecticut, Delaware, Massachusetts, Nebraska, New York, and Pennsylvania also force you to consider their “convenience of the employer” rule, which specifies that workers who are assigned to an office/state for the employer’s convenience are subject to income taxes in that state. These rules may be inoperable in the pandemic environment.
Employee/Individual Income Tax
To reiterate, the employee’s home state has general jurisdiction to impose income tax on the entire amount of the individual’s income from whatever source derived. When the work state (and associated withholding) differs from the home state, an individual will generally receive a credit in their home state for taxes paid to other work states. Note that the threshold for employer withholding requirements may differ from the threshold for employee taxability. In some states, working one day is enough to trigger nonresident income taxes, while other states use thresholds ranging from 10 to 60 days, and some determine taxes based on income a nonresident earns there. As such, each individual taxpayer must determine where tax filings are required based on their presence and location of earnings. According to a recent survey by the American Institute of CPAs, most Americans who have worked from home during the pandemic do not know about the ways their state income taxes might be affected. About half of Americans worked remotely during the pandemic, and the majority of those do not know that working remotely in other states can affect the amount of state taxes owed. Further, less than half of respondents indicated they had tracked the days worked in other locations, and even fewer had requested a change to their state withholding.
Based on the above issues, employers/employees should consider the following items:
- The shift in employees’ principal work states may require employees/employers to process and implement new withholding certificates.
- In states where temporary relief from nexus/withholding/individual income tax has been granted, when does the relief expire? In many states, this is tied to the deemed end of the pandemic emergency set by the governor or may be a specific date. Note that these “expiration dates” have often been extended during 2020.
- Incentives or tax credits related to employees or compensation may be affected based on the shift in work locations.
- Should HR policies be amended to address a temporary or permanent remote workforce? For example, social media company Reddit recently announced that it would not only allow its workers to live anywhere they please but establish a single pay scale regardless of their specific location.
- In addition, HR policies and systems may need to be revised to properly identify, track, and report employee wages based on their actual work location(s) as opposed to an assigned office location.
- Current litigation over these matters may clarify which jurisdiction has the authority to impose taxes related to remote workers. The primary case (so far) involves Massachusetts and New Hampshire. Massachusetts amended a regulation on the sourcing of income of nonresident and certain resident employees telecommuting due to the COVID-19 pandemic. The rule includes measures continuing to source to Massachusetts the income of nonresident employees of Massachusetts employers temporarily telecommuting due to the pandemic. New Hampshire filed suit in the U.S. Supreme Court, as it does not impose an income tax on individuals and so viewed it as an attack on New Hampshire’s sovereignty and power to tax (or not tax in this instance) its own residents. The New Hampshire petition contains several other intricate arguments as well. See State of New Hampshire v. Commonwealth of Massachusetts, U.S. Supreme Court, motion for leave to file a bill of complaint, filed October 19, 2020.
To learn more about these issues and how it could affect your organization or for assistance with these taxes related to a remote workforce, contact your BKD Trusted Advisor™ or submit the Contact Us form below.