Government mandated work-from-home orders have created a remote workforce, creating a host of complex state and local tax issues for both employers and their employees. Even as these orders expire, a common trend among employers is to implement flexible, long-term (and in some cases permanent) work-from-home arrangements.
Among the many important issues for employers to consider will be whether they will now be subject to various business taxes in the state or local jurisdiction where the employee is working remotely (e.g., sales, income, franchise taxes) and whether the employer should be withholding state and local income taxes from the employee’s paycheck in the remote work jurisdiction. Additionally, it is important for employees teleworking to understand the extent to which they are subject to income taxes in each jurisdiction, to ensure they file proper individual income tax returns.
Business Tax Nexus
The physical presence of a single employee working remotely in a state could be sufficient to establish business tax nexus between an employer and that state. If tax nexus is established, the employer may be required to comply with the tax laws of that state and may be responsible for registering for and paying business income and franchise taxes, sales and uses taxes, and other taxes in the state that the employer is not ordinarily accustomed to paying.
Employer Income Tax Withholding
States typically require an employer to withhold from an employee’s paycheck an amount sufficient to cover the expected state income tax liability incurred by the employee. Generally, employees are subject to income tax withholding in the state and city where they are performing services.
If an employee teleworks in a different state, they are generally subject to income tax withholding in the employer’s state and could also be subject to income tax withholding in their state of residence. However, in some cases, reciprocal agreements between states prevent the employee from being subject to multiple withholding. In addition to state income tax withholding, cities with an income tax also require employers to withhold city incomes for both resident and non-resident employees performing services in the city.
If an employee is no longer performing services in a city that imposes an income tax, careful consideration should be given as to whether that employee is still subject to city income tax withholding in a particular jurisdiction.
State Response to Telecommuting during COVID-19 Pandemic
In response to tax nexus concerns relating to business and payroll tax withholding requirements, some states issued guidance temporarily suspending tax nexus thresholds when employees are working remotely as a direct result of the COVID-19 pandemic. A common theme among the several states implementing such guidance is adopting a “status quo” approach where an employee’s change in work location directly resulting from the pandemic will generally be ignored, and the employee will be treated as if they are still physically working at the employer’s home location.
States that have addressed either business tax nexus or withholding concerns due to teleworking during the pandemic include Alabama, California, District of Columbia, Georgia, Illinois, Indiana, Iowa, Maine, Maryland, Massachusetts, Minnesota, Mississippi, New Jersey, North Dakota, Oregon, Pennsylvania, Rhode Island, and South Carolina.
States have not adopted uniform rules in dealing with these teleworking nexus issues. For example, some states have provided guidance as it relates to either corporate income or franchise taxes, but not withholding taxes (and vice versa). Some guidance applies status quo treatment only in situations where an employee is required to work remotely due to a government mandated order or a physician order pursuant to a COVID-19 diagnosis.
Other states take a more flexible approach by simply requiring that the employee be teleworking in their state due to the COVID-19 pandemic. Hence, each state’s guidance should be studied independently to fully understand the scope, including the point in time at which the guidance will expire (which varies among the states). The issue of tax nexus and remote work is of utmost importance to states as they face enormous budget pressure resulting from the pandemic.
For example, New Hampshire has filed a lawsuit in the United States Supreme Court, challenging Massachusetts’ ability to tax New Hampshire residents. The case is pending in the United States Supreme Court and its outcome could have a widespread impact for all state and local governments.
Businesses implementing long-term or permanent work-from-home arrangements will not be able to benefit indefinitely from the COVID-19 guidance released by certain states. Once the guidance expires, the state’s original nexus laws will apply, potentially subjecting many employers to new tax obligations. More importantly, most states have not adopted any guidance at all. It is imperative that employers and employees utilizing work-from-home arrangements contact their attorneys and tax advisors in order to ensure proper compliance with each state’s nexus and tax reporting requirements.