Five months into the COVID-19 pandemic, about one-third of all Americans are working from home, suddenly forcing many companies to try to figure out the state tax (or non-tax) implications of telework.
Even though some states have announced policies about the tax implications, which generally provide some form of amnesty against the typically expected outcomes (nexus or withholding), employers may not know if their employees are telecommuting from new states, or if those employees want to start doing so permanently.
Not only have these considerations become more complex since our June article about this topic, but the urgency of employers’ need to respond to these considerations is accelerating:
- Most states have not announced any tax-related policy guidance in this area. This may give businesses heartburn about having telecommuters there, because states’ pandemic-driven economic woes create incentives for them to seek new sources of revenue.
- Even in states with amnesty policies, with South Carolina being a good example, all employers run the risk of having any telecommuters there ask to convert from temporary to permanent telework status, a request that if granted would disqualify those employers (and the employees) from otherwise available protections.
- Even though federal intervention remains a possibility, with several bills recently introduced to restrict the nexus and withholding implications of COVID-19-related telework, these bills’ prospects remain unclear.
To proactively address these challenges, employers need to better understand the state tax (and non-tax) implications of telework and to compile data about their current telework footprint and their telecommuters’ long-term plans.
The evolution of states’ telework tax policy
Prior to COVID-19, state tax policy regarding the implications of telework was largely undefined. While a handful of states expressly held that in-state telecommuters gave their employers nexus there, most states were silent about this topic. By contrast, most states have always required employers to withhold payroll taxes from the wages of employees who worked there (whether from telework or not). Despite these requirements, many employers had no simple way to tell whether their employees were working outside the state of their primary work location and were often limited to reviewing employees’ expense reports for hotel or rental car reimbursement requests, which indicate a new work location.
COVID-19 has caused around 15 states to announce guidance regarding the nexus and/or withholding implications of COVID-19-related telework, some of which includes amnesty provisions. However, with most states (including population centers like California, Florida, New York, and Texas) remaining silent about these issues, the related uncertainty in most states has raised the stakes for many employers.
Traps for the unwary
For the states with amnesty-like policies for COVID-19-related telecommuting, two key problems have surfaced. First, though couched in terms of not disrupting employers’ state withholdings, some states’ policies may result in either double taxation of employees, or taxation that would not otherwise have occurred. Second, these amnesty periods have a limited and often undefined duration, leaving employers with little time to evaluate their current and expected long-term telecommuter footprint.
1. Excessive taxation/withholding
Individuals who reside and work in different states generally owe individual income tax to both states: the resident state would tax his/her worldwide income and the nonresident state would tax his/her income “sourced” to that state. To mitigate the resulting double taxation, the individual’s resident state typically grants a credit for taxes paid to the work state.
For many years, all but six states have sourced wage income to the employee’s physical work location. However, these six states (Arkansas, Connecticut, Delaware, Nebraska, New York and Pennsylvania) have historically used a so-called “convenience of the employer” rule, which always sourced wage income to the employer’s state – even if the employee telecommuted from another state – unless the out-of-state work was required by the employer. Because most states disagree with the “convenience” sourcing rule, they would often deny credits for taxes their residents paid to “convenience” states. The widespread expansion of telecommuting under COVID-19 has only amplified this problem, particularly for telecommuting employees previously based in New York.
In addition, as a result of COVID-19 there are at least four states and some cities — including Massachusetts, New Jersey, Pennsylvania, Rhode Island, Ohio municipalities and St. Louis, Missouri —- whose approaches have the same effect as a “convenience” rule. These jurisdictions freeze the source of a nonresident employee’s wage income at his/her pre-pandemic work location, even for telework later performed in another state or city. These provisions have already triggered legal action: by New Hampshire, whose governor on August 5 ordered its’ Justice Department to investigate the issue, and by an Ohio Senator, who on August 11 introduced legislation to overturn H.B. 197’s adoption of a “convenience” rule for municipal income taxes. New Hampshire’s August 21 letter to Massachusetts lays out a variety of challenges that all such rules may face.
2. Conflicts between states
Employers should rely upon states’ COVID-19 tax amnesty policies only with caution because they are fraught with problems. For example, some states’ amnesty periods are generically tied to “the pandemic,” a loosely defined concept that makes it hard for employers to predict when the related protections will end. Other states’ amnesty periods are tied to a specific governmental COVID-19 order, which could be problematic when border states’ COVID-19 orders conflict.
For example, if a federal COVID-19 order expired but Georgia’s COVID-19 order did not, a resident of Alabama who continued teleworking there rather than returning to a Georgia office would create Alabama nexus and withholding obligations for the employer, despite being legally unable to return to the Georgia office. In two states, the amnesty period ends on a date that is independent of any COVID-19 orders (including those of their own states): Oregon (ends on November 1, 2020), and South Carolina (ends on September 30, 2020).
States do seem to agree on one thing, however: Once any employee’s telework status changes from temporary to permanent, the regular nexus and withholding rules will apply. As a result, now is the time for employers to gather the data needed to prepare for the state tax environment they will inherit once states’ COVID-19 amnesty policies end.
State and local non-tax implications
Employers also have always needed to consider the related non-tax implications in areas such as state unemployment insurance (SUI), minimum wage laws, and Secretary of State (SOS) “doing business” registrations. Under COVID-19, this list has only grown to include topics such as expansions of safe/sick leave rules to cover COVID-19-related absences, as well as “reasonable accommodation” requirements to permit teleworking for employees whose disabilities increase their risk for contracting COVID-19.
Employer efforts to identify their new telework populations
In order to respond to these issues strategically, employers must obtain data about their teleworking employees’ work location and future plans. For example, employers should survey employees about potential telework from new states and about employees’ potential desire to permanently telework from new states. Employers may also use employees’ IP address to identify their current work-from state. Otherwise, employers might not learn about their employees’ new telework location until they get a nexus questionnaire and face a potentially significant tax bill.
For example, according to Georgia’s FAQs, “If [an employee] remains in Georgia after the temporary remote work requirement has ended (whether voluntarily or if required by the employer), the normal rules for determining nexus … will apply. As such once the temporary work requirement ends, the company would have nexus [in Georgia].”
Federal legislation may also motivate employers to adopt an employee time-tracking system because recent proposals generally require employers to withhold payroll taxes in the state of each employee’s primary work location unless they have implemented such a system.
A federal solution?
For many years, federal legislation has been repeatedly (though unsuccessfully) introduced to create a single, uniform threshold for when employers must withhold payroll tax on their nonresident employees’ wages. COVID-19 has renewed interest in this kind of legislation, with multiple bills recently introduced to address telework’s nexus, withholding, and apportionment implications. The following chart highlights the key components of major proposals, with the most significant one (S. 3995) receiving support from the AICPA and COST:
|Remote and Mobile Worker Relief Act of 2020 (S. 3995) (June 18, 2020)
||Taxability: Wages may only be taxed by employee’s state of residence, or a nonresident state in which the employee works for more than 90 days (2020) or 30 days (after 2020)
Sourcing: During the covered period, default to employee’s primary work location; use employee’s actual work location only if employer uses a tracking system. After the covered period, may use employee’s annual determination of time spent or optional tracking system
|During the covered period, nexus not created solely by an employee working at a location other than the primary work location due to COVID-19 conditions; apportionment assigned to primary work location
||Starts on date when an employee’s remote work started
Ends on the earlier of
(1) Dec. 31, 2020 or
(2) the date when the employer simultaneously allows
(i) the employee, and
(ii) at least 90% of its permanent workforce, to return to their primary work location
|American Workers, Families, and Employers Assistance Act (S. 4318) (July 27, 2020)
||Same as S. 3995, but 30-day withholding floor ends in 2024
||Same as S.3995
||Same as S.3995
|Remote Worker Relief Act of 2020 (H.R. 8056) (Aug. 14, 2020)
||Same as S. 3995, but only addresses telework performed through Dec. 31, 2020
||Same as S.3995
||Same as S.3995
Given the significant contention in Congress regarding any COVID-19 relief package, however, the prospects of these federal bills remain unclear.
Regardless of states’ telework tax policies, companies should generally perform a thorough nexus study before registering in any new jurisdiction to understand whether they may have risk there for prior periods. Otherwise, by registering the company may disqualify itself from using the state’ voluntary disclosure agreement program and trigger an audit of prior periods that could create significant tax, penalty, and interest.
Just like COVID-19 itself, only time will tell what the future holds for the state tax implications of telecommuting. Until some kind of moonshot surfaces, employers should build their state tax COVID-19 preparedness strategies by compiling data about the location and future plans of their telecommuter populations, and by closely monitoring related guidance from state taxing authorities.
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