The coronavirus pandemic has threatened cities economically, hammering revenue-generating restaurants, sport venues, and entertainment sites for months because of government lockdowns and company mandates that employees work from home.
Municipalities with city wage taxes have taken an even bigger hit as they’ve watched their revenue bases decline. Some are issuing guidance to clarify that workers—many of whom haven’t worked from their employer’s location since the spring—owe taxes sourced to the workplace.
That stance could land municipalities in legal hot water just as it has sparked litigation between Massachusetts and New Hampshire, practitioners told Bloomberg Tax. At least one taxpayer suit challenging the fairness of a city’s tax policy has been filed, and more could be on the way.
“This is extra-territorial taxation,” said Lynn Gandhi, partner at the law firm Foley & Lardner LLP in Detroit. “It’s more than unfair, it’s unconstitutional.”
‘Dystopic’ Buckeye Case
Columbus, Ohio, has been sued over its decision to require workers to pay the city’s 2.5% income tax for work performed at home even if the employee’s home is outside the city’s jurisdiction. Other cities, including St. Louis, Wilmington, Del., and Charleston, W. Va., have similar requirements, policies that could also lead to legal battles, practitioners said.
For cities with many employers, like Wilmington and Columbus, wage and earnings taxes are the primary source of revenue. Such cities are “highly motivated to maintain that revenue base,” Matt Melinson, Philadelphia-based partner at Grant Thornton LLP, said.
Columbus’ Buckeye Institute, a free-market think tank, filed suit in July against the city and the state by challenging a law (H.B. 197) passed early in the pandemic. The Ohio Legislature required work done from home to be treated as if performed at one’s workplace for municipal income tax purposes.
Robert Alt, president and CEO of the Buckeye Institute, said the law—coming on the heels of a statewide stay-at-home order barring employees from going to the office—was “straight out of a dystopic novel.”
St. Louis Refund Denials
In St. Louis, nonresidents working from home instead of at their employer’s location in the city must continue to pay the city’s 1% earning tax, according to the office of the city’s Collector of Revenue.
In previous years, nonresident workers could file a refund claim for city taxes withheld on whole days worked outside St. Louis, said Pamela A. Huelsman, principal in the tax services group of the public accounting firm Brown Smith Wallace LLP in Missouri.
The city has recently indicated such refunds will be denied for remote work-from-home employees, she said.
“There is no relief” for telecommuters during the pandemic, said Thomas Vollmer, deputy at St. Louis’ Collector of Revenue Office. He pointed out “the company still made a profit from the work you’re doing at home” as a reason for the city’s move and said that business travel would be treated differently.
Vollmer said nonresidents of St. Louis can fill out a refund request for review and acknowledged that nonresidents could potentially sue St. Louis for a refund denial.
Charleston, W. Va., said it hasn’t waived its weekly city service user fee of $3 per worker for employees temporarily working from home. The employer’s location continues to receive the benefits of city services, it said.
But in a twist, Charleston has been saying residents of the city who are temporarily working from home for an employer located outside the city shouldn’t have the user fee withheld from their pay, practitioners said.
Employers are beset with complexity when sorting out tax withholding rules, especially when a state has one policy and a city has a different one.
Huelsman of Brown Smith Wallace lives in Illinois while her firm is located in Missouri. Once she started working from home due to the pandemic, her wages were subject to Illinois withholding tax and no longer to Missouri’s.
Although the Missouri firm isn’t based in the city of St. Louis, if it were, the city would require her to pay the St. Louis earnings tax. “That would be a strange result—owing tax to state of Illinois and City of St. Louis” in neighboring Missouri, Huelsman said. When states have “disconnect in their withholding rules, there could be risk of double taxation,” she said.
Three-Dimensional Tax Chess
Philadelphia is exempting nonresidents from the city’s wage tax when they’re working from home if required to by an employer or government mandate. Employers face a choice: Stop withholding the city tax from their employee’s paychecks, or continue withholding, allowing employees to file for refunds in 2021, said Grant Thornton’s Melinson.
By contrast, Pennsylvania has issued guidance saying nonresident employees in a state without reciprocity with Pennsylvania—such as Delaware and New York—still must pay income taxes to Pennsylvania, and employers are required to withhold compensation paid, Melinson said. When two states have a reciprocity agreement, residents of one state don’t have their income taxes withheld if they work for an employer in the other state.
The Keystone State’s guidance is contrary to the law and places both the employee and the employer in a difficult position, said Mike Semes, professor of practice in the Graduate Tax Program at Villanova University in Pennsylvania.
“This is kind of like playing three-dimensional chess,” Semes said. “It’s not just the state you have to look at, but the multiple localities that may or may not be imposing taxes.”
“Employees and employers do not necessarily have common interests,” said Ted Bernert of Baker & Hostetler LLP in Columbus. When an employee’s tax situation changes, employers are often required to change their withholding systems, and having an employee in a new location could make the employer subject to taxation in a jurisdiction where it wasn’t before, he said.
The situation raises questions for what’s next for city and state tax policy after pandemic orders are lifted, and many employees continue working from home, Bernert said.
Municipalities are “going to have to look at different ways to generate revenues” after the pandemic, he said and added “it’s the elephant in the room.”