Since March, thousands of employees have ceased working at their employer’s traditional place of business and now telework from home, whether from a laptop at the kitchen table or at a new desk hastily situated in the basement (or another quiet space away from children, who are now themselves telecommuting to school). Moreover, perhaps thousands more of these workers have stopped living in their traditional residences, as they have temporarily relocated to a vacation house, a family member’s house, or, for example, a rental home far away from their usual urban dwelling.
In a nation of 50 separate states, each with its own sovereign power of taxation, these shifts in workplace and other migrations across state lines can carry significant, complex, and perhaps surprising state and local tax consequences for both businesses and individuals alike. This article will briefly highlight several key pandemic-related issues that taxpayers should be cognizant of.
Taxation of Telework
Teleworking has always had the potential to create a host of tax compliance burdens for employers and employees. With advances in technology, telecommuting has slowly been creeping into the American workforce for the past two-plus decades. But with onset of the Covid-19 pandemic, a large segment of the U.S. workforce experienced a sudden and mass shift to telecommuting, and nearly 10 months into the pandemic, as businesses and workers have begun to adjust to the “new normal,” the move to a remote workforce seems certain to become, at least to some degree, a permanent fixture of the workforce landscape.
For many employers, this likely means that their workforce may now be geographically dispersed across several, if not many, new jurisdictions beyond their original state footprint. While several state tax authorities have issued guidance addressing the implications of teleworkers crossing state lines due to Covid-19, more than half have remained silent. As such, businesses and their advisors need to take an inventory of their workforce and examine the laws of each state where they have employees performing services in order to evaluate the potential state and local tax implications.
The Business—Nexus and Related Considerations
It is generally accepted that telecommuting employees can create “nexus” on behalf of an out-of-state business, potentially leading to various tax obligations in a new state(s), including payroll taxes, income taxes, sales/use taxes, and various local taxes, among others. An employee’s presence in a new state could mean that the out-of-state employer suddenly has nexus with the new state, necessitating registration, filing, and becoming familiar with the tax laws of jurisdictions that previously were never a concern.
From a payroll tax perspective, businesses need to ascertain whether employee relocations may create new withholding requirements. Generally, employers are charged with withholding income taxes based upon the location where an employee performs services. With a virtual workforce, employees may now be working from anywhere. Some states, such as New Jersey, have granted temporary relief by relaxing payroll nexus standards for Covid-19 teleworkers. Others, like Massachusetts and New York, have issued guidance attempting to continue to tax nonresidents as if they were still working at the employer’s place of business. Each of these situations can create a complex set of new issues that employers need to consider and address.
From an income tax perspective, businesses need to evaluate whether any new nexus or employee presence impacts their formulas for multistate apportionment of business income. While nexus determines whether a state can impose tax, apportionment determines how much income is subject to tax. The presence of employees or company property in a new jurisdiction may impact apportionment formulas based on payroll and property factors; newly establishing nexus in a state in which the company happens to have high in-state sales volume may create a significant new tax liability if that state utilizes a single-sales factor apportionment formula. Further, establishing nexus in a new state through employee relocations could potentially impact other items such as Public Law 86-272 protections, as well as alter pre-pandemic cost of performance sourcing methodologies.
From a sales and use tax perspective, businesses may find themselves with registration, collection, and remittance obligations in states reflecting their altered workforce footprint. In 2018, the U.S. Supreme Court’s Wayfair ruling abrogated the physical presence requirement and ushered in economic nexus for sales tax purposes. Consequently, many remote sellers of taxable goods and services are now subject to each state’s recently enacted Wayfair provisions. These do include small-seller threshold exceptions; in many states, a remote seller does not have economic nexus with a market state unless it exceeds greater than $100,000 or 200 transactions in that state. However, with a virtual workforce, the presence of a telecommuting employee in a new state could trigger the physical presence standard, and thus the business would no longer qualify as a remote seller, losing the small-seller threshold protections.
At present, only a handful of states have issued any guidance addressing Covid-19 teleworker nexus considerations. Several states (e.g., New Jersey) have granted nexus relief, but only for a temporary period. Other states (e.g., New York and Massachusetts) have sought to clarify that they, indeed, expect to collect personal income taxes arising from these new arrangements, notwithstanding the pandemic. In summary, businesses need to begin to plan now to avoid future nexus compliance pitfalls and to be in a position to assess state and local tax risk arising from employees working remotely from states where the employer previously had no state or local tax filing obligations.
The Worker—Residency & Related Considerations
In a multistate environment, individuals should also consider the potential impact of residency rules. From a personal income tax perspective, there are essentially three ways a state, which administers a personal income tax, can impose its tax. Two apply to residents, who owe tax on their worldwide income. There are two ways to qualify as a resident. The first is domicile, which reflects an individual’s true home. The second is statutory residency. Under New York’s and New Jersey’s rules, for example, if a taxpayer maintains a permanent place of abode and spends greater than 183 days in that jurisdiction, then that individual is treated as a resident (i.e., a “statutory” resident) regardless of whether they are a domiciliary of their home state. The third way states can impose tax is to impose tax on nonresidents upon any income sourced to the taxing state. For example, a New Jersey resident who traditionally works in New York for a New York business would owe tax to New York on their income earned from that business and sourced to New York.
Tax migration can raise both residency and nonresident allocation issues. Is a New Jersey resident who used to work in Manhattan but now teleworks from home, in fact, subject to tax by New York? Is a New York City resident who has relocated to her Florida beach home able to stop her New York payroll withholdings? If a Brooklyn-based business allows its workforce to go virtual, and an employee terminates his New York lease, and then moves to his parents’ in Illinois for three months, and then with laptop in hand moves with some friends to a rented house in Hawaii for six months, is he able to claim he changed his tax residence away from New York?
These are complex questions that require a rigorous facts and circumstances analysis. There are multiple permutations reflecting the reality that Covid-19 has dispersed a large swath of the U.S. workforce across the country. Some relocations will be permanent, others will be only temporary, but all of them require a careful tax analysis.
Tax Planning—The Time is Now
These are complex issues in large part because there is a patchwork of different rules on a state-by-state basis. Employers and employees should monitor their relevant states for guidance addressing these types of issues. Further, these complexities are aggravated by conflicting state rules. For example, New Hampshire has sued Massachusetts over Massachusetts’ efforts to continue to impose income tax on New Hampshire residents who used to work in Massachusetts but are now working from home in New Hampshire. Similarly, New York has stated its intention to continue to impose income tax on New Jersey and Connecticut residents who used to work in New York but are now working from home in New Jersey and Connecticut. In response, the New Jersey legislature has considered legislation requiring the state Treasurer to examine New York’s efforts to tax New Jersey residents and to consider whether New Jersey should join in New Hampshire’s litigation. Employers and employees need to understand the current landscape of the varying state rules and consider undertaking a nexus diagnostic/review so that they can minimize their state and local tax risks.
All of these issues are only intensified by the budgetary crunch that many states and localities are facing due to the pandemic-induced recession. The border disputes between New Hampshire and Massachusetts and perhaps between New York and New Jersey have the potential to lead to either significant opportunities for interstate cooperation or interstate skirmishes where taxpayers may suffer the brunt.
At this point, there are more questions than answers. Businesses, employees, tax advisors, and state policymakers should continue to examine these issues. Companies must evaluate their telework footprint and track the locations of their workforce. Individuals need to understand the complex residency rules affecting their state tax compliance burdens. Needless to say, all taxpayers should be vigilant and monitor their states for additional guidance.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Corey L. Rosenthal, JD, is a Principal at CohnReznick and Practice Leader of the State and Local Tax Services practice.
Lance E. Rothenberg, JD, LL.M, is a Senior Manager with the State and Local Tax Services practice.