No one envisioned how long the COVID-19 pandemic would necessitate remote work, and then how many people would want to continue working remotely on a permanent basis. Along with workplace disruption, is the effect on state and local tax payments. While not an issue for those who live and work in a single location, this becomes challenging for those who live in one tax location but work in another. This impacts both where a company should remit withholding payments, and the ultimate question of who will collect income taxes for each worker’s income.
With hybrid work arrangements becoming a feature of the new workplace, employers should be very deliberate when they communicate and execute policies relating to an employee’s work location.
1. Domicile or residency
In general, personal income taxes must be filed in the state where the taxpayer’s primary residence is located. This is true for both W-2 employees and 1099 independent contractors. The state in which that primary residence is located is often referred to as that person’s domicile. While your domicile may be in one state, you may also be considered a resident in another state. By statute, if you are present in a state more than 183 days in a year, you will be considered a resident of that state and required to file a tax return.
Additionally, taxpayers may need to file a nonresident tax return in states from which they receive a W-2.
Keeping relevant documents and records, including utility bills and EZ pass statements, can help support claims if an employee is audited. Having a daily calendar can be helpful as well.
2. ‘Convenience of the employer’ rule
While most states tax a remote employee based on residence, some states follow a “convenience of the employer” rule. Under this rule, days worked are counted as days worked at the employer’s location if the employee is working remotely for his or her own convenience and not the employer’s necessity. In this case, the core question is: Which state is entitled to income tax on an employee’s wages, the state in which he or she lives or the state where the employer is located?
Some states have reciprocal agreements stating that employees only have to pay tax in the state where they live, no matter whether they are doing so for necessity or convenience. Employees in this category will only have taxes withheld for one state, provided both the residence and workplace are in states with reciprocity.
Taxpayers affected by these rules will not necessarily be double- or triple-taxed because they usually are eligible for tax credits. However, each state is likely to expect the employee to file a tax return, and, because each state has its own tax rates, a taxpayer’s total tax bill may be higher when the higher-rate jurisdictions collect the increment left after applying the tax credit. If the employee lives and works in different states and those states do not have a reciprocal agreement, the employee will need to file tax returns in each state.
In addition, some cities and localities, such as New York City and Yonkers, New York, have their own taxes, which means some taxpayers will need to pay taxes to three agencies.
These issues may eventually reach the US Supreme Court, but the Court has so far declined to hear recent cases relating to telecommuting tax policy.
Remote workers can cause additional work for employers which must comply with payroll tax withholding rules for accurate payroll tax withholding and reporting.
Business tax filings may also be affected, including filings regarding passthrough business income, unemployment insurance withholding, workers’ compensation, disability, sales tax, and employment requirements.
Sales tax can be a particularly thorny issue since it takes only one employee working in a location to create an economic nexus in that city or state, particularly if that employee bills their time to clients through the company.
There are many rules to consider, including how long COVID-19 rule suspensions or modifications will be in force. In many instances, these rules have either expired or will expire shortly.
To be sure to avoid any penalties, individual taxpayers and businesses need to be familiar with the tax law in their resident state and any other states in which they operate. Contact R&A to assist you in navigating this changing area of the tax law.
About this Author
Adam specializes in international tax planning and analysis. Since 2012 he has coordinated offshore compliance submissions, international tax training relating to foreign pension plans, foreign investment in US property, and general foreign compliance. In addition, in conjunction with legal counsel, he assists international families regarding planning, entity structure, and transaction analysis.