As a supplement to our initial article on the issues involved with remote employees, we delve into the changes in the workplace and the subsequent legislative and judicial developments that have occurred since December 2020.
In response to the federal and state COVID-19 restrictions, many business entities quickly established work-from-home (WFH) policies as temporary stopgap measures to maintain business operations. Due to the considerable extended period of time under pandemic restrictions, business entities found that these WFH policies could maintain successful business results and that employees tend to favor work outside the normal office environment. As a result, many businesses that implemented WFH policies during the pandemic have transitioned these policies (or some version thereof) to permanent working arrangements. These WFH policies can take the form of fully remote employees working from anywhere all of the time to hybrid/flexible work arrangements that split time in and out of an assigned office.
Based on the myriad of surveys1 on this topic, it is safe to reach the following conclusions:
- Remote work is now an established workplace norm.
- Over half of the companies in the U.S. generally offer some form of remote work arrangement for at least some of their workforce.
- The vast majority of employees take advantage of their employer’s remote work arrangements and seek/prefer such arrangements when job hunting.
- The majority of employees would prefer to work remotely more often than their employer's policy permits.
While businesses have been quick to adapt to remote employee policies, the temporary exclusions and special tax provisions implemented during the pandemic have largely expired, leaving taxing jurisdictions playing catch up on dealing with this new trend. As such, complications from remote employees continue to have the potential to create a maddening 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. Remote employees located in jurisdictions where the employer previously had no connection may generate nexus for a variety of business taxes (namely corporate income tax, sales tax, and/or property tax), as well as state registration/licensure. A limited volume of employees (and any associated employer-owned property) present in a taxing jurisdiction generally creates sufficient physical presence to trigger business tax nexus in about 75% of states.
Another issue connected to nexus and tax filings is that incentives or tax credits related to employees or compensation amounts may be affected based on the shift in work locations. Existing incentives should be reviewed to help ensure there is no negative impact to continuing qualification. On the upside, remote employees may create opportunities to claim new incentives. Note that in many cases, these incentives need to be applied/negotiated before the employees are present in the jurisdiction.
Employers 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. Otherwise, when 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. Connecticut, Delaware, Massachusetts, Nebraska, New York, and Pennsylvania (and until recently Arkansas) 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 (even if they do not actually work there).
In addition, while wages based on time in state lead to easier computations, other payments, e.g., bonuses, stock options, deferred compensation, etc., may be more difficult to allocate and/or special reporting rules may apply. Note that the above considerations require an employer to track employee work locations in order to apply the proper jurisdictional requirements. As such, employers need to have defined HR policies to specify what their remote work arrangements are, what documentation is required, and possibly even limit where employees may work. Employers also may want to consider using a time reporting system that tracks the day-to-day work locations of its remote employees to document and support their payroll reporting on a by-employee and by-jurisdiction basis.
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 fall 2020 survey by the American Institute of CPAs, about half of Americans who worked remotely 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 any change to their state withholding.
The most significant development regarding remote employees was a non-event in that the U.S. Supreme Court declined to hear New Hampshire v. Massachusetts.2 New Hampshire filed a challenge to a Massachusetts rule that required nonresidents working remotely from home but normally assigned to a Massachusetts office to pay Massachusetts income tax on those earnings. While the case drew more than a dozen friend-of-the-court briefs by other states urging the court to take up the challenge, the court ultimately declined to hear the case likely influenced by the acting U.S. Solicitor General’s amicus brief arguing against the court taking up the case.
Without federal clarification on the issue, the burden of determining the proper tax impact of remote employees now falls on the respective state and local taxing authorities. Below is a sampling of various legislative, administrative, and judicial developments that reflect the differences now present across the country.
- Alabama Tax Tribunal, Docket No. Inc. 22-390-LP, March 8, 2023
The Alabama Tax Tribunal affirmed the Department of Revenue’s individual income tax assessment for tax year 2020 against a taxpayer working remotely from Idaho. The taxpayer appealed, contending that he relocated to Idaho with the intention of making a permanent change in residence. The tribunal found that even though the taxpayer abandoned his Alabama domicile, he was clearly engaged in a regular and legal employment with his employer, which was located in Alabama, and he continued to transact business in Alabama via the employment. Therefore, the taxpayer’s income from his employment was a result of his conducting business in Alabama and was properly taxable to Alabama.
- Illinois General Information Letter IT-21-GC-0006 (issued August 31, 2021)
The Department of Revenue issued guidance on corporate income tax nexus due to remote employees. The requesting taxpayer was a business incorporated in another state with no sales or customers in Illinois, but it did have an employee working remotely full time from their home in Illinois. The department specified that the taxpayer would be required to file a state tax return if it was registered to conduct business in the state and was required to file a federal tax return.
- Michigan Department of Treasury Notice: Remote Employees (issued February 1, 2023)
The Department of Treasury (which has administered the City of Detroit's income taxes since 2015) issued guidance for nonresidents of the City of Detroit who previously worked in the city and who now work remotely on how the city taxes compensation. For resident employees, the employer must generally withhold tax from all taxable compensation, no matter where earned. For nonresident employees, the employer must generally withhold on compensation paid to the employee only for work done or services performed in the city. Because for most employers, the permanence of the remote work situation was unknown or undecided, withholding for most employees continued as normal. Accordingly, the department has issued instructions for nonresidents with Detroit compensation or withholding on how to report their compensation, how to prepare corrected returns; and how to correct any overwithholding for future returns.
- Boles v. City of St. Louis, Cause No. 2122-CC00713, January 19, 2023*
The Missouri Circuit Court held that employees who lived and worked outside of St. Louis are entitled to a refund of the St. Louis payroll earnings taxes withheld from their pay because the tax applies only to days of work physically performed within the city. The city refused to issue earnings tax refunds for tax year 2020 to Boles and the other plaintiffs on the argument that “services rendered” under the city code means services provided to a St. Louis employer, or customer and the employer, that received the benefit of the services and was at all times located within the city.
- Montana Department of Revenue Release: Remote Employees (issued April 10, 2022)
The Department of Revenue issued individual income tax filing information for Montana residents working outside the state and for part-year residents and nonresidents working remotely from Montana. The information includes that: 1) part-year residents and nonresidents working while located in Montana will generally create Montana source income, regardless of their residency; 2) Montana source income includes wages, salary, tips, other compensation, and business income for services performed in the state; 3) Montana residents must report and pay tax on income received for work performed outside the state; and 4) Montana residents may be eligible to claim a credit for taxes paid to another state when filing a return with the DOR if they paid tax on that income in the other state.
- Zelinsky v. New York State Department of Taxation and Finance, N.Y. Div. of Tax Appeals, No. DTA 830517, petition July 22, 2021
This pending case has a Connecticut resident challenging the New York convenience of the employer rule that allows the state to tax nonresident personal income while working from home. Edward A. Zelinsky is a professor at Yeshiva University’s Cardozo Law School in New York City and resident of New Haven, Connecticut.
- Schaad v. Alder, Ohio Ct. App., First Dist., No. C-210349, February 7, 2022*
This is one of several cases in Ohio posing a constitutional challenge to municipal authority to impose local income taxes on telecommuters working for in-city employers during the COVID-19 pandemic as granted by Ohio House Bill 197, Laws 2020. Prior to the pandemic, Schaad worked part of the week in his Cincinnati office and part of the week either traveling or working from home. Schaad’s employer withheld Cincinnati municipal income tax from his pay. After the stay-at-home order went into effect, Schaad mostly worked from his home in Blue Ash, Ohio. The city refused to grant him a refund for the days he worked from home due to the stay-at-home order. A three-judge panel of the Court of Appeals of Ohio affirmed an earlier dismissal of the case.
- Morsy v. Dumas, Ohio Ct. Com. Pl., No. CV21 946057, summary judgment granted September 26, 2022
In a slightly different twist to the Ohio local tax question, the City of Cleveland and the State of Ohio were deemed to have failed to establish a basis for jurisdiction to tax a nonresident of Ohio on income generated by work performed at her home in Pennsylvania. Cleveland must pay back local income tax withholdings to a senior executive of a Cleveland-based biotech company while she was working remotely from her home in Blue Bell, Pennsylvania.
- Zilka v. Tax Review Board City of Philadelphia, Pa., No. 20 EAP 2022, brief November 18, 2022
The Supreme Court of Pennsylvania will review a Philadelphia resident’s demand for a refund under the city’s wage tax for a portion of the city and state income taxes paid while working in another state. The dispute involves state and city taxes paid between 2013 and 2016, when Zilka lived in Philadelphia but worked in Wilmington, Delaware. The Commonwealth Court’s ruling affirmed earlier determinations by the Philadelphia County Court of Common Pleas and the Philadelphia Tax Review Board denying Zilka’s request for a refund. During the three relevant years, Zilka’s employer withheld amounts for the Philadelphia wage tax, Wilmington earned income tax, Pennsylvania income tax, and Delaware income tax. Zilka claimed a credit for the Delaware tax (5%) to offset the Pennsylvania tax (3.07%) on her Pennsylvania return. Zilka also claimed a credit for the Wilmington tax (1.25%) and the balance of the Delaware tax to offset the Philadelphia wage tax. The case emerged after the department denied Zilka’s request for the remainder of the Delaware tax. The department’s brief faulted Zilka’s analysis of the U.S. Supreme Court’s 2015 ruling in Comptroller of the Treasury of Maryland v. Wynne, which found Maryland’s failure to provide a full credit for income taxes paid to other states to be unconstitutional. The court, however, “did not rule that a truly local tax must be offset against state taxes or that a state tax and a truly local tax must be aggregated,” the department wrote.
- Puerto Rico Act 52-2022 (passed, effective June 30, 2022)
The “Law for the Stabilization of the Puerto Rico Public Finances” makes a number of income tax revisions, including defining a “remote worker” as a nonresident individual who performs services as an employee for the benefit of a nonresident person. Remote employees will not be considered an economic link with Puerto Rico. The reporting and withholding obligation on wages paid by every employer will not apply to payments made after December 31, 2021 for services performed by a remote worker.
*These cases are under appeal.
To learn more about these issues and how they could affect your organization or for assistance with these taxes related to a remote workforce, please reach out to a professional at FORVIS or submit the Contact Us form below.
- 1“Americans Are Embracing Flexible Work—and They Want More of It,” mckinsey.com, June 23, 2022
“Why Working From Home Will Stick,” National Bureau of Economic Research Working Paper 28731, nber.org, updated July 2023
- 2New Hampshire v. Massachusetts, U.S. S.Ct., Dkt. No. 154, Orig., motion to file bill of complaint denied June 28, 2021