Understanding the convenience of the employer rule

Most people are accustomed to paying state personal income tax in their state of residence. However, for people who live and work in different states, taxes may also apply to the state where they’re employed. In the case of living and working in different states, your state of residence is legally entitled to tax your worldwide income, regardless of the source. However, your nonresident state may only tax your income from sources within that state.

The general rule for sourcing wage income is to the state where you physically performed the work for which the wages are associated. However, there are two major exceptions to this rule: states that have reciprocal tax agreements with one another and the convenience of the employer rule.

Reciprocal tax agreements

When states have reciprocity arrangements with one another, you only need to pay taxes on the related wage income to your state of residence. You don’t need to follow the usual rule of sourcing your income and paying taxes to the nonresident state where you work. Note that reciprocity only applies to wage income. It doesn’t apply to any other type of income, such as business income reported on a state Schedule K-1 or intangible income, such as interest and dividends.

Convenience of the employer rule

The NY convenience of employer rule, or convenience rule, sources wages to the location of a nonresident employee’s assigned office or principal place of business. The rule applies even if the underlying work was physically performed at a home office in another state. But there are exceptions if the employee is working from home because of an employer requirement rather than for convenience. New York State’s detailed guidance can help illustrate how the rule applies to at-home work and what qualifies as a home office. In some cases, New York will still source your wages to New York, even if you work from home outside of New York state.

The convenience of the employer test is used to source the wage income of nonresidents in these states:

• Connecticut
• Delaware
• Nebraska
• New York
• Pennsylvania

Arkansas briefly had a convenience rule that was put in place in February 2020 and ended on April 21, 2021.

Impact of the convenience rule on the out-of-state credit

The convenience rule presents challenges because it produces a very different sourcing outcome than the general rule. It can also result in individuals paying state income tax on more than 100% of their wage income, due to the lost out-of-state credits on their resident state tax returns, potentially leading to double taxation.

For example, New Jersey and Connecticut previously applied their own sourcing rules to compute out-of-state credits. They also didn’t have a convenience rule for sourcing wage income, while nearby New York did. Therefore, if you lived in New Jersey or Connecticut but were assigned to an employer location in New York, you would pay tax to both your resident state and New York on the same wage.

This historical approach in Connecticut and New Jersey was understandable because they didn’t want their taxing policies to be dependent on those from another state.

However, states also need to keep their voting residents happy. As a result, Connecticut adopted its own convenience rule for tax years beginning on or after January 1, 2019. But the rule only applies to workers who reside in a state that also uses the convenience rule. For the first time, Connecticut residents who paid tax to any other state that employs the convenience rule, such as New York, became entitled to an out-of-state credit against their Connecticut income tax.

As of December 5, 2022, New Jersey advanced Tax Bill No. 3128 to follow suit and create a NJ convenience of employer rule for residents of states that impose a similar test. If enacted, this law would mean that residents of New Jersey who are working from home in New Jersey, but who have an assigned office in New York, would be entitled to a credit for income taxes they pay to New York under New York’s own convenience rule. The bill would also offer a $2,000 tax credit for New Jersey residents who successfully request and receive a work transfer back to New Jersey from an out-of-state location.

How Wipfli can help

As more employers adopt a telework mindset, both businesses and individuals will need to be more aware of the convenience rule and its implications for remote working and remote employees. For more on how your business can manage the tax considerations of a remote workforce, including tax filing, withholding and overall tax liability, watch our on-demand webcast: Answering your biggest tax questions around remote workers.

Wipfli is here to provide guidance and support you as you navigate the complexities of nonresident employee taxes. We can help you understand the convenience of the employer test (COE test) and how it affects sourcing income for your nonresident return. Whether you’re dealing with issues related to your work location, employer’s convenience or employee’s convenience, we can assist with your tax planning needs. Contact us today to learn how we can help you navigate the intricacies of the convenience tax and help ensure compliance with the reciprocal convenience rule in various states.