The explosion in the number of remote workers in light of the pandemic has brought to light various state and local tax issues that have long been simmering. While a handful of states have made attempts to address these concerns and a legislative fix by Congress has also been proposed, a unified scheme to prevent such difficulties has not yet been implemented. As a result, employers are finding that their remote workforce has the potential to create unexpected tax exposure in jurisdictions where such employers may have little to no contact other than the mere presence of a telecommuting employee.
Tax Issues for Employers
Generally, tax reporting and payment obligations for a business arise in a state where the business is considered to be "doing business." Among other contacts, merely having an employee working part-time in a state can be considered sufficient contact or nexus with a state for a business to be considered to be "doing business" there. Typically, doing business in a state will mean that a business is subject to the state's income, franchise, gross receipts, and sales and use taxes. States may provide for relief from tax reporting and payment obligations for contacts with the state such as trade shows and conventions, but, for the most part, such relief does not exist with respect to remote workers. While some states have recently provided relief such that having employees forced to work remotely as a result of the pandemic will not subject a business to state taxation, such relief is temporary.
The rules vary among the states regarding when the presence of employees in a state will be considered to result in sufficient nexus with a state to subject a business to the state's taxing jurisdiction. The Multistate Tax Commission has model rules that have been adopted in many states, under which nexus results if a threshold level of activity with respect to payroll, property, or sales is exceeded in the state. The payroll factor threshold results in nexus based on having merely $50,000 or more in compensation paid to personnel in a state. Regardless of this threshold testing, many states take the position that the presence of a single employee may trigger nexus for tax purposes.
Employers that have shifted to increased reliance on a remote workforce may find themselves incurring unexpected state and local tax burdens pursuant to the above nexus principles. This would lead to numerous issues for employers, including subjecting the employer to income, franchise, gross receipts, and sales and use tax in another jurisdiction. A business with employees in multiple states must examine each state's nexus policy to first determine whether the business has nexus with the state. Some states have adopted economic nexus standards similar to the above-described payroll threshold standard. Others have not, and the determination of whether nexus with these states exists may be unclear.
Once an employer has determined that it has nexus with a particular state, the next inquiry is whether the employer has a filing or payment obligation with such state. Typically, if nexus exists, an employer has a tax filing obligation even if it does not have a payment obligation. Furthermore, an employer may have a payment obligation even if its only contact with the state is the presence of the remote employee. Most states generally subject a business with nexus to tax using an apportionment formula based on (1) sales in the state or (2) a combination of sales, property, and payroll in the state. Clearly, having any remote workers in a state that taxes income based in part on in-state payroll would open up a business to taxation by such state, even if the business has no further contacts with the state. Furthermore, although the property determination is fairly straightforward, the determination as to whether a business has in-state sales can be significantly more complex. Each state applies its own rules to determine whether sales are in state – while often this determination is made on the basis of the location of the customer, some states source sales to a particular state to the extent an in-state employee is responsible for negotiating or facilitating the sale. Again, if an employer has employees working remotely in multiple states, in the absence of further guidance, the employer must look into each state's specific sourcing rules to determine whether, and the extent to which, a payment obligation arises.
Tax Issues for Employees
In addition to employers, remote working could significantly impact employee taxes (and the employer's obligations for withholding those taxes). At the outset, employees will need to determine whether, by virtue of a remote working arrangement, the employee's place of residence has changed for state income tax purposes. If an employee no longer lives and works in the same state, the employee may have filing and payment requirements in multiple states, and what the employee views as his or her principal place of residence may have changed by virtue of such arrangement.
Employers that likewise have obligations with respect to employee compensation and with employees in multiple jurisdictions must decide which state to withhold income tax for or reconsider which state to pay unemployment insurance premiums to. Typically, income tax withholding by an employer is based on the employee's state of employment. Unemployment insurance premiums are paid to the state where the employee's work is localized. If an employee works entirely within one state for the year, that particular state is the payee jurisdiction, even if the employer's headquarters or the employee's usual office is located elsewhere. If the employee works in multiple states, then the appropriate payee is determined by looking at the employee's base of operations (if one exists), the employer's base of operations, or the residence of the employee.
Particularly confusing are the six states that reverse the typical withholding process by having adopted the "convenience-of-the-employer" rule. New York is among the states that apply the convenience-of-the-employer rule, exemplified as follows: in New York, an employer is required to withhold New York income tax from employee wages if the employee (1) works from home for his own convenience (as opposed to the employer's convenience) and (2) spends at least one day of the year in New York.1 Thus, an out-of-state employer may be required to withhold New York income tax on the wages of an employee residing in New York and working from home during the pandemic—even if the employer otherwise conducts no business in New York. As of the date of this article's publication, no guidance has been issued by New York clarifying whether the above "convenience" rule applies to employees working from home because of the pandemic.
State-Level Short-Term Solutions
Recently, a handful of states have issued guidance relaxing the above economic nexus requirements with respect to out-of-state employers that utilize remote workers. While not uniform across states, the basic idea behind such guidance is that the mere presence of remote workers will not create tax or reporting obligations within a jurisdiction. States that have implemented some form of this guidance include Alabama, the District of Columbia, Georgia, Indiana, Maryland, Massachusetts, Minnesota, Mississippi, New Jersey, North Dakota, Pennsylvania, and South Carolina. However, the majority of states, including high-tax states such as California and New York, have yet to adopt similar measures.
It is important to note that the above relief measures have been taken strictly with respect to the current pandemic. In other words, after the pandemic ends, these measures will likely go away. Many taxpayers, however, will continue to work remotely. It is clear, then, that a more permanent solution will be needed when that time comes.
Federal Response
In lieu of cooperation between the states, a legislative response at the federal level may be needed to remedy this issue. Such legislation has been around for years, but never generated any significant momentum in Congress. One such proposal was introduced earlier this year: the Mobile Workforce State Income Tax Simplification Act sought to establish a uniform threshold under which employees would be required to file state tax returns and businesses would be required to withhold state taxes only after an employee had worked more than 30 days in a state. This bill went through a few iterations before appearing in its latest form as part of the Health, Economic Assistance, Liability Protection, and Schools Act (HEALS Act).
Under the latest HEALS Act proposal, employees who work in multiple jurisdictions would only be subject to income tax in (1) their jurisdiction of residence and (2) any jurisdiction in which they perform employment duties for more than 30 days during the year (90 days during 2020). This exclusion would also apply to income tax withholding and reporting requirements for employers. The proposal would also deem any wages earned by remote employees in a different jurisdiction as being earned in the employer's jurisdiction; employers with a system that tracks where employees perform duties, however, could elect out of the above rule. Finally, the proposal would modify state law residency rules such that remote work would, by itself, be insufficient to establish a nexus to a jurisdiction for any employers or employees. Thus, for example, an employee working from home in New York for a California employer would not, by herself, create a business nexus in New York for the California employer.
While it is uncertain whether the HEALS Act or a relatively similar successor bill will ultimately be enacted, it is possible that the pandemic has shed enough light on this issue to finally generate legislation at the federal level.
The Future
With the majority of states refusing to relax their nexus rules and the fate of the HEALS Act being uncertain, it remains to be seen whether an effective solution will be implemented to relieve employers of state and local tax burdens created by remote workers. Even if federal legislation is enacted, it may provide only temporary relief for the duration of the pandemic, even while many commentators agree that remote work is here to stay. Furthermore, as remote workers continue to accrue time in new jurisdictions, such jurisdictions may gradually become less inclined to give employers a tax break and take the view that sufficient time has passed to treat the presence of those workers as creating a nexus for their employers.
Venable's SALT team will continue to monitor the situation and stands ready to advise with respect to any remote work issues.