Today you may be working from a mountain hideaway, and tomorrow, your beach vacation home. The COVID-19 pandemic has created a new world of telecommuting options for employees with the ability to work remotely. Some employees have completely transitioned from working in a traditional office environment to living, and often working, in a different location (i.e., telework). But before settling in with a laptop on a veranda in a dream destination, be aware that such remote working arrangements could potentially have tax implications.
State tax considerations for employers
Sourcing of income between jurisdictions
States have a variety of ways they source income derived within, or in some cases, outside of the state where an employee works. Some states tax income based on the “convenience of the employer” rule. Simply put, this means the income is sourced wherever the employer is located. Only six states currently apportion income under this method. Other states tax an employee based on where the work is physically performed. Still others tax residents using an approach like the federal government—taxing all income from whatever source derived.
Creation of additional filing requirements
Various thresholds must be met to generate a filing requirement, depending on the state and based on different metrics—e.g., reaching a certain income threshold within a state or working within a state for a distinct number of days during the year. Please note, some states have adopted reciprocity agreements with other states to simplify reporting requirements. Thus, it is important to work with your employer to track which state(s) you are working in and whether additional withholding should be made from your paycheck, or whether you are subject to a state’s reciprocity agreement. In most cases, a taxpayer likely is eligible for a tax credit for taxes paid to other states, to eliminate double taxation.
Payroll tax requirements
When an employee works in more than one state, an employer may be obligated to withhold and remit income taxes to each relevant state. A company’s responsibilities for withholding state income tax for remote workers are complicated by the fact that states have different rules and thresholds at which an employer must withhold. As a result, employers and employees should analyze current withholdings and revise as necessary if additional state withholding requirements are triggered.
As an additional consideration, because of the shift to teleworking, states are reconsidering income sourcing and overall taxing methodologies. To boost short-term revenue, states facing an exodus of teleworking employees could implement the “convenience of the employer” rule and treat employees as if they worked out of their company’s office in another state, potentially resulting in double taxation. Such drastic changes in tax policy would likely lead to questions of legality and ultimately require the response of the federal government and courts. Employers must monitor potential state legislative tax regime changes to ensure tax withholding and filing compliance for their workforce.
It is also important for employers to consider potential implications for their state income tax obligations. To the extent employees are teleworking from states in which employers do not have offices, such physical presence may result in income tax obligations in those new states. Several states have previously determined that this teleworking arrangement establishes a presence in the state where the teleworking employees reside, thereby subjecting employers to income tax obligations. Many states have started to provide employers a temporary reprieve from income tax obligations in situations where COVID-19 has forced employees to work from home. However, any reprieve will be temporary, and employers should be cognizant of the ever-changing state tax landscape.
State tax obligations for employees
An employee and employer need to track all employee working locations to ensure compliance with all state tax obligations. As the example illustrates, when taxpayers live in one state but work in another, they may have tax liability and income tax return filing requirements in both states. Potentially impacted employees need to understand the state income tax filing and withholding requirements of each work location to ensure proper compliance and to avoid any potential penalties.
Familiarizing yourself with different state and local tax jurisdictions can help alleviate an unfortunate tax surprise when it comes time to file your taxes. Most state websites provide guidance for what is sourced within the state and whether any credits are applicable within that state. By working with a tax professional now, you can help ensure you file all appropriate tax returns and receive any credits for which you are eligible.
As an example, suppose you normally live and work in State A. During COVID-19, you now work remotely in a second home in State B. State B taxes nonresidents on all income received within or for services performed within its state. In this situation, you are subject to nonresident individual income tax in State B if your wages exceed a certain threshold. The thresholds will differ from state to state. Now assume State A, your permanent residence, taxes income from whatever source derived; therefore, all income earned will be taxed by State A. When filing your individual income tax return for State A, you can claim a tax credit for taxes paid to other states. The credit is limited to the amount of tax that would have been due had that income been taxed at State A’s income tax rates. The credit received for taxes paid to a state with a higher state tax rate would be limited.
Let’s assume the same facts, but you are now working remotely and living in State C. State C does not impose an individual income tax upon its residents. Unfortunately, since your permanent residence is in State A, which imposes an individual income tax, you are still fully subject to tax at State A’s rates. It does not matter that the state you are temporarily living in does not impose an individual income tax.
For assistance with evaluating your tax obligations, or with any matter related to individual tax filing, small business tax advisory, or business management, contact a PYA executive below at (800) 270-9629.