Income Tax Nexus & Withholding Implications of Telecommuting Employees During COVID-19

Will states stop the spread … of nexus?

As part of the ongoing efforts to fight and reduce the spread of COVID-19, several states in the U.S. have enacted stay-at-home orders and similar measures forcing employers to provide flexible work arrangements and allow employees to telecommute. This temporary telecommuting could have some unforeseen state tax consequences for employers and employees.

Income Tax Withholding

In general, states require employers to source employee compensation to the state wherein employees perform their regular work activities, regardless of their state of residence or the employer’s location. Employees can now perform their work duties remotely, even in states where their respective employers have no physical location. This situation can have income tax withholding implications if no reciprocal agreement exists between the states involved. A reciprocal agreement is an agreement between two states that allows employers to withhold tax for employees in their residency state despite the fact the employees are working in the other state.

In response to COVID-19, some states have released guidance to help taxpayers comply with withholding tax requirements related to telecommuting. The guidance released and relief provided are temporary in nature and usually tied to the federally declared period of emergency or subject to state-specific extensions. For example, the temporary withholding requirement and nexus rule in South Carolina are currently set to expire on December 31, 2020.¹

The following states have released specific guidance indicating they won’t require out-of-state employers to change their income tax withholding for employees when temporary changes in work location occur due to a response to the COVID-19 pandemic.²

Employers and employees would be well advised to consider the withholding requirements of both the former and current work state to determine if there may be conflict in the two states’ approaches to telecommuting during the pandemic.

• Alabama³
• Georgia⁴
• Indiana⁵
• Iowa⁶
• Kentucky⁷
• Nebraska⁸
• New Jersey⁹
• North Dakota¹⁰
• Pennsylvania¹¹
• Rhode Island¹²

Illinois provided withholding guidance indicating that working more than 30 days in Illinois will require income tax withholding from employees working from Illinois for out-of-state employers. If met, non-Illinois employers will be required to register and withhold income tax from those employees.¹³

Income Tax Nexus

Currently, 45 states and the District of Columbia impose an income tax and have their own nexus standard. Nexus is the link between a taxpayer and a state that provides the state the ability to impose its tax laws upon the taxpayer. It’s a complicated concept, but in broad terms, nexus can be created by a taxpayer’s physical presence; a factor presence (sales, property, or payroll of a certain percentage or amount); or a substantial economic presence in the state. Once state nexus is established, a taxable presence is created, and states can impose a tax obligation on an out-of-state taxpayer. For employers, telecommuting employees can potentially create nexus in new states or cause an employer to exceed the protection of P.L. 86-272 in a state. P.L. 86-272 is a federal law that restricts states from imposing an income-based tax on a company if the company’s only activity in the state is the solicitation of sales of tangible personal property in the state to be fulfilled from an inventory outside the state. The following states have specifically addressed telecommuting and provided temporary relief from nexus creation by out-of-state taxpayers whose only activity in the state is telecommuting employees during the pandemic:

• Alabama¹⁴
• California¹⁵
• District of Columbia¹⁶
• Georgia¹⁷
• Indiana¹⁸
• Iowa¹⁹
• Maryland²⁰
• Massachusetts²¹
• Minnesota²²
• Mississippi²³
• New Jersey²⁴
• North Dakota²⁵
• Oklahoma²⁶
• Oregon²⁷
• Pennsylvania²⁸
• Rhode Island²⁹
• South Carolina³⁰

From the states with specific mention of income tax nexus and COVID-19, only Kentucky said it will review nexus determinations on a case-by-case basis.³¹

Employers and employees should be cognizant of the varying rules among the states in which their employees are telecommuting. While certain states may provide relief during the pandemic, states will likely revert to their former practices after the dates indicated in their COVID-19 relief guidance. In addition, cash-strapped states may take a more aggressive approach to asserting nexus after these dates. Employers should re-evaluate their withholding and business tax obligations as relief fades, especially if employees begin telecommuting on a full-time basis. 

For more information, reach out to your BKD Trusted Advisor^™ or use the Contact Us form below.

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¹ South Carolina Department of Revenue, Information Letter 20-24 (08/26/2020).
² Reciprocity agreements among states and requirements for active-duty military and their spouses should be reviewed separately.
³ Alabama Department of Revenue, Coronavirus (COVID-19) Updates (05/12/2020).
⁴ Georgia Department of Revenue, Coronavirus Tax Relief FAQs (05/01/2020).
⁵ Indiana Department of Revenue, COVID-19 FAQs.
⁶ Iowa Department of Revenue, COVID-19 FAQs on Income Tax (05/15/2020).
⁷ Kentucky Department of Revenue, COVID-19 Tax Relief: Frequently Asked Questions (07/16/2020). 
⁸ Nebraska Department of Revenue, FAQs about the Income Tax Changes Due to the COVID-19 National Emergency (05/19/2020).
⁹ New Jersey Department of the Treasury, Tele-Commuting and Corporate Nexus (03/30/2020).
¹⁰ North Dakota Office of State Tax Commissioner, Coronavirus North Dakota Tax Guidance (04/15/2020).
¹¹ Pennsylvania Department of Revenue, FAQs (04/10/2020).
¹² Rhode Island Department of Revenue, Advisory 2020-22 (05/26/2020).
¹³ South Carolina Department of Revenue, Information Letter 20-11 (05/15/2020).
¹⁴ Alabama Department of Revenue, Coronavirus (COVID-19) Updates (05/12/2020).
¹⁵ California , Franchise Tax Board, COVID-19 Frequently Asked Questions for Tax Relief and Assistance (9/11/2020).
¹⁶ D.C. Office of Tax and Revenue, OTR Tax Notice 2020-05 (04/10/2020).
¹⁷ Georgia Department of Revenue, Coronavirus Tax Relief FAQs (05/01/2020).
¹⁸ Indiana Department of Revenue, COVID-19 FAQs.
¹⁹ Iowa Department of Revenue, COVID-19 FAQs on Income Tax (05/15/2020).
²⁰ Comptroller of Maryland, Tax Alert 05-04-20 (05/04/2020).
²¹ Massachusetts Department of Revenue, TIR 20-10 (07/21/2020).
²² Minnesota Department of Revenue, COVID-19 FAQs for Businesses (05/18/2020).
²³ Mississippi Department of Revenue, Response to Requests for Relief (03/26/2020).
²⁴ New Jersey Department of the Treasury, Tele-Commuting and Corporate Nexus (03/30/2020).
²⁵ North Dakota Office of State Tax Commissioner, Coronavirus North Dakota Tax Guidance (04/15/2020).
²⁶ Oklahoma Department of Revenue, Nexus and Telecommuting Due to COVID-19 (06/02/2020).
²⁷ Oregon Department of Revenue, COVID-19 Tax Relief Options (07/28/2020).
²⁸ Pennsylvania Department of Revenue, COVID-19 FAQs (04/03/2020).
²⁹ Rhode Island Department of Revenue, Advisory 2020-24 (05/28/2020).
³⁰ South Carolina Department of Revenue, Information Letter 20-11 (05/15/2020).
³¹ Kentucky Department of Revenue, COVID-19 Tax Relief: Frequently Asked Questions (07/16/2020).