With more people working from home due to the COVID-19 pandemic, both employees and their companies are facing tax issues, even if the employee has relocated to a low-tax state.
Some states have been enacting a so-called “convenience of employer” rule that subjects employees to state income taxes for the employer’s state even if the employee has moved out of state for their convenience. The Supreme Court’s ruling in the 2018 case of South Dakota v. Wayfair may bolster a state’s argument that a business has a physical presence, or nexus, in states where their remote employees reside and work from home.
As states seek to recoup the costs they’ve borne over the past year and a half due to the pandemic, taxing out-of-state workers may be a relatively painless way for them to regain some of the revenue they might otherwise lose from people who move away in hopes of reducing their tax bills and housing costs.
“What has happened in a number of states is these people are still domiciled in their state but are working remotely elsewhere,” said Janet Bernier, a state and local tax partner at BDO USA. “They run into the issue where they have filing requirements to states: their home state as a domiciliary and a second state as a statutory resident where they have spent 183 days or more. We have a number of individuals that have had during COVID dual filing requirements or dual state tax filings as residents. That’s important because a resident is taxed on all of their income. Nonresidents are only taxed on the income earned while working within the state, or sourced within the state.”
Companies may face taxes from other states as well due to the nexus created by out-of-state employees. “When we look at the companies that this impacts the most, it’s really going to be more of the middle-market companies that don’t have a footprint in every state, or some of the smaller entrepreneurial startup companies because they don’t have that taxable nexus or presence in other states, or maybe they only have it in a handful of states,” said Bernier.
Employee-tracking systems
Employers are finding the landscape shifting on their state taxes as a result of the COVID-19 pandemic, and the Delta variant is prolonging the work-from-home trend for many businesses and their employees. “One of the biggest things that the pandemic revealed for most work environments, at least for tax purposes, is there was a pretty clean line that could be drawn for where you live and where you work,” said Carlton Huntley, a Thomson Reuters tax expert and content editor, and an adjunct professor of state and local tax at the University of Florida. “One of the things that a lot of employers didn’t anticipate really until tax time was a disconnect between those two things. A very simple problem that has popped up is employers don’t know where their employees work like they did before the pandemic. I think the biggest challenges in going from remote work to back in the office and now back to remote work with the emergence of the Delta variant is having some sort of system in place that makes declaring or determining where your employees even work, to determine their state of employment requirements, to determine your own as a corporation or partnership, and the tax-paying implications.”
Companies need to develop systems for keeping track of where employees are and new policies and processes for how to deal with their taxes. “The biggest thing at tax time and then moving forward is companies are having to develop systems to track their regular day-to-day employees in the same way that they used to have to track their traveling employees,” said Huntley. “A lot of companies had protocols in place for traveling salesmen as well as those who have to work on location to be dispatched to different states. They had protocols in place for tracking their own presence in the company, but what you’re finding now is those protocols for a lot of places are now necessary not just for their traveling employees but for their entire workforce.”
States that had relaxed their earlier requirements for paying taxes last year during the outbreak of the pandemic are now starting to return to their older requirements. “During COVID, there were perhaps about two dozen states that gave us a grace period,” said Bernier. “They basically came out, either in their website FAQs, or in a proclamation, and said we are not going to enforce sales and use tax nexus, nor are we going to enforce corporate tax nexus, if the only thing you have in a state is a remote worker during COVID. That was very good. We saw it in a number of states like Massachusetts, New Jersey and Connecticut. There were a number of states that just sat silent. New York never said boo about it, which was interesting.”
Reasserting nexus
The states’ willingness not to assert nexus during COVID was in some cases part of the state of emergency they declared last year during the pandemic, but now some states are ending those grace periods. “The first state to roll off this, to my knowledge, was Pennnsylvania,” said Bernier. “Pennsylvania basically said effective June 30, our state of emergency is over, and what that means is they are free to enforce the nexus laws if you have a remote worker in the state. I believe Massachusetts plans to roll off of the state of emergency for the pandemic in September. So what’s going to happen to employers? They’ve had a respite. They haven’t had to increase their compliance beyond what they had prior to COVID in many states. It’s going to be quite important for businesses to really track where their employees are and also be aware of which states will be requiring nexus as they come off of COVID. Some states have never addressed the issue.”
The rules for making such determinations are not easy for many employers and employees to make without help from their accountants. “In the last year I have had more questions about the impact of remote workers than I ever could have imagined,” said Bernier. “It has taken front stage with clients and with the employees who are crossing borders and working remotely.”
States have not been consistent with their tax rules during the pandemic. “The majority of the states, when they issued a statement during COVID that they were not going to enforce state tax nexus, some of them said specifically nexus for corporate income taxes, and some of them said corporate income taxes and sales taxes,” said Bernier. “The problem with the states is that there’s such inconsistency. There’s no uniformity, but the states did indicate that this was during the state of emergency, so now again there’s no uniformity as to when the states are going to end each state’s state of emergency. Businesses are going to have to be very cognizant and see where their employees are working.”
That will be yet another adjustment for employers to make during the pandemic. “Businesses are trying so hard. COVID was such a disruptor,” said Bernier. “They are trying to be more employee friendly. They are trying to put remote policies in place to accommodate this new remote work or telecommuting. They are trying to reduce their real estate needs or their real estate costs, but what’s going to happen is they’re going to have increased tax compliance costs. It may not equate dollar for dollar into more taxes, but it will be increased compliance. That’s really what we’re going to see, both in corporate income taxes as well as sales and use taxes, and also payroll withholding filings. It’s really a big increase in compliance for those companies that were not multistate tax filers prior to COVID.”
Convenience of employer rules
The tax rules differ not only between the states, but also the federal government. “It’s making it incredibly complicated because most states and federal [government] as well have some sort of a disconnect between your actual home and your tax home,” said Huntley. “Your actual home, the residence where you’re currently living, can create certain tax obligations when you actually work there. Those were simple for people prior to the pandemic. For most people, it was the exact same place. People choose their places of residence based on where they work. Now there is such a disconnect that we have to modify, clarify and interpret rules to deal with this unique situation those rules were never really meant to address. Those rules were built for those outlier situations where people were working and living in different locations, but now that is not necessarily as much of an outlier situation as it once was. One of those rules is really causing a lot of hardship. A lot of things define your tax home as places you work, and if you happen to be working remotely, they’re basically going to consider you taxable at the place where you work, unless you’re working not for the convenience of the employer, but for your own convenience.”
States with convenience-of-employer rules include Connecticut, Delaware, Massachusetts, Nebraska, New York and Pennsylvania.
“One of the most vexing states is my home state of New York,” said Bernier. “New York imposes this outrageous rule called the convenience of employer, which means that if you are working for a company based in the state as a New York State based employee, but you are working outside the state at home for your own convenience, they will source the wages earned from working outside the state right back to New York. So, as a nonresident of New York, you could be subject to very, very significant taxes in New York, and in your home state you could also be subject to tax.”
Some workers can find themselves facing what amounts to double taxation. “What ends up happening is that those employees are oftentimes running into double tax,” said Huntley. “Basically, they’re being taxed by the place that they live and the place where those services are being delivered or whose company they’re being delivered in New York, even if they haven’t set food in New York in eight months. So it’s creating those types of issues for a lot of workers and companies that never had to deal with those withholding nuances before.”
New York does have some limitations on the rule, however. “There are some mechanisms for a credit for nonresident taxes paid,” said Bernier. “It’s not a dollar-for-dollar credit. What we’ve been seeing in the past few months is that anyone who was formerly sourcing 100% of their wages to New York, and all of sudden now they’re sourcing less to New York because they’re working remotely, is receiving notices. New York has been very aggressive about sending out notices reminding people about the convenience of employer rule and asking these nonresident taxpayers to provide information as to where they were working throughout the 2020 tax year.” Arkansas recently repealed its convenience of employer rule, but it’s still applicable in the other six states. “My speculation is that it was repealed to make Arkansas a very taxpayer friendly state where they’re able to get employees who work across state borders,” said Bernier. “I don’t know whether we’re going to see any such repeals in New York, Delaware, Nebraska or Pennsylvania.”
The convenience of employer rule can also hit companies when an employee comes back into the state temporarily for a company meeting. “A lot of people don’t realize that in a number of the Northeastern or Atlantic states like Pennsylvania or New York that do have the convenience of employer rule, when they come back into the jurisdiction for those key meetings, it will trigger taxes in those jurisdictions on their wages earned,” said Bernier. “And it will trigger the days worked remotely at home to be sourced back to those states that have the convenience of employer rule unless they meet one of the exceptions. That’s very challenging because one of the exceptions is a high standard called the ‘bona fide home office of the employer.’ That means the employer has to declare your home office as their office and hold it out as such. We’re creating nexus for the company if they were to make that convenience of employer accommodation or exception.”
Edward Zelinsky, a law professor at Yeshiva University’s Cardozo School of Law, has filed a lawsuit challenging the convenience of employer rule in New York on constitutional grounds, although the Supreme Court rejected an earlier case in which the state of New Hampshire sued New York over the rule.
“The New York rule is onerous,” said Bernier. “It is a disincentive for many people to work for New York-based employers, and Professor Zelinsky sees that the longstanding United States Supreme Court decision in Quill was overturned by the landmark case of Wayfair. We went away from physical presence, and we use an economic nexus standard for sales tax. It was a big departure. It rejected stare decisis. So he feels that the time is ripe now for the courts to take his case.”
Compliance burdens
In the meantime, those who moved to low-tax states hoping to avoid taxes may find themselves facing the same big tax bills.
“I have been doing state and local income taxes for over two decades, and over the course of time, I’ve had many high net worth individuals who were looking to retire leave high taxing jurisdictions and go to lower-taxing jurisdictions, typically Florida or Texas,” said Bernier. “I even had one client going to Wyoming. We’ve had a number of clients who have looked to relocate and change their domicile to either a low-tax or no-tax jurisdiction, and that always becomes a little bit of an issue for high net worth individuals because they can maintain their home in their old domicile. They can maintain their ties and connections. So we work with them on how to do this properly.”
It’s not only people planning their retirements who are looking to move to save on taxes. “I have had everything from a 28-year-old broker to CEOs of companies looking to change their domicile because now all of a sudden they realize they can work remotely,” said Bernier. “They can work at an incredible distance from the home base of the office and do it successfully. Companies have to consider whether this increases their compliance burden by having people in all these other jurisdictions. I couldn’t even give you an estimate of the multiples of people that are approaching us on relocating to these lower-taxing jurisdictions. It’s a huge number.”
Businesses are wondering how these employee relocations will affect their taxes. “I have a number of very large companies that for whatever reason perhaps didn’t have any employees in some obscure states, and they contacted us and said, ‘We have this employee in the state. Does that change our tax position?’ And the answer was sometimes it did,” said Bernier. “Sometimes it gave them nexus and filing requirements that they didn’t otherwise have. The physical presence put them in a state where they didn’t meet these sales and use tax Wayfair economic nexus thresholds, but all of a sudden they triggered old-fashioned physical nexus. A lot of states have gone from corporate income taxes to market-based sourcing, so we typically just have a sales factor to allocate their income across multiple states. But there are a few states that still use cost of performance, particularly when we have flow-through entities, and there are a number of states that still have a three-factor formula, so having payroll in the state will change their apportionment in the state and they have a change in taxes. The biggest impact is the state and local tax compliance on all fronts — income tax, sales tax and withholding — but the secondary impact could be that it could create some taxes or some changes in apportionment that weren’t anticipated.”
Companies have been forced to develop systems and processes to keep track of all their employees to ease the compliance requirements. “At the higher levels, like Google, Twitter, etc., they’re able to adapt relatively easily,” said Huntley. “They’re abreast of all of this, and they have internal tax departments that are ready to deal with this, but for a lot of startup software companies, or for companies that have maybe $2 million or $3 million in receipts, or for companies who even before the pandemic had a tenuous grasp of all the state and local nuances, are basically having to rapidly say, ‘Hey, where are all of our employees?’ Before, you knew where they were. There were several companies that we had to advise to basically put questionnaires out saying, ‘Hey, where are you guys working? Where do you live? Not only where do you work, but where do you live?’ When you think about it, how many jobs have actually asked you, ‘Hey, where do you live?’ It’s not only where do you live when you first start, but if you move from a house to a different house, it’s ‘Hey, do you still live at 8 Oak Tree Lane?’”
Lawmakers in Congress have tried to address the problem with legislation, but so far it hasn’t been passed during multiple congressional terms. “They have re-proposed the Multi-State Worker Tax Fairness Act,” said Bernier. “It’s an act that different Congresses and senators had proposed over the last decade to create uniformity for employee mobility, but that act has never passed in both houses in 10 years. It’s been proposed agan, and it’s fascinating that even with a triggering event such as this pandemic, with remote working and crossing state lines as a way of life, it still couldn’t get passed during a pandemic, so I don’t think we’re going to see the federal government step in. The Supreme Court declined to take the case of New Hampshire v. Massachusetts. Congress cannot seem to pass the Multi-State Worker Tax Fairness Act or its predecessor, the Employee Mobility Act. I think we’re going to continue to have a lack of uniformity among states, and we’re going to have businesses as well as individual employees who cross state lines with bigger compliance burdens and bigger filing burdens at the state tax level.”
