Due to the COVID-19 pandemic, employees have increasingly become remote workers and are changing how and where their work is done. Telecommuting usually implies working from a personal residence, but that residence may be in a state outside of the state where the employer is located.
Sourcing Employee Income
Because states typically source employee income based on where the service or employment is performed, remote workers may be creating a significant new state tax footprint, which will require them to file and pay taxes as nonresidents or statutory residents. This is in addition to complying with tax obligations of their state of residence. And, states will need to adjust to these changes beyond 2020, as long as remote workers continue to live and work in a refuge state, a term used to describe a location outside the state of residency or employment.
To tax the wages of employees, states typically impose two types of taxes: the employer withholding tax and individual income tax. Generally, an employer is required to withhold tax on employee wages at the primary work location. Employees that travel outside of their state of residence or employer state, even if just for one day, may be required to file an individual income tax return and pay tax on wages based on where their services were performed.
Most states do not have physical presence thresholds, like a minimum number of days before an individual is required to file and pay taxes. The Mobile Workforce State Income Tax Simplification Act of 2020 (H.R. 5674) has been reintroduced to the U.S. House of Representatives. This legislation would create a uniform nexus threshold by limiting the state taxation of non-resident workers to those that have performed services in the state for more than 30 days.
However, this bipartisan bill is unlikely to move forward in the near future. Employers may currently take the practical approach of not withholding for employees in states to which they only travel for one or two days a year and, instead, choose to only withhold for the employee at the primary work location in the employer state.
Taxpayers and employers receive tax relief in states with reciprocal personal income tax agreements where compensation paid to resident employees is not subject to the tax of the employer state. In states without reciprocal agreements, to avoid double taxation, both nonresident and statutory residents in refuge states will rely on a credit for taxes paid in the resident state for tax relief. Based on the different state standards for granting a credit, it is unclear, whether a taxpayer would receive an offsetting credit. And, states that impose a “convenience of the employer” rule, add yet another layer of potential double taxation.
One Take on Double Taxation
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Taxing Remote Workers
For the individual income taxation of temporary remote workers, the following are among the states that have issued guidance on withholding and income tax filings for temporarily relocated workers, and a few have issued recent guidance that reiterates the state’s current rules that remote workers create a taxable presence without exception for temporary relocations due to the COVID-19 pandemic. This summary is NOT an all-inclusive list, as states continue to issue new guidance.
In Georgia, an employer is not required to withhold Georgia income tax on employee wages earned while temporarily working in Georgia because they are not considered to be Georgia income.
Illinois takes the position that employee compensation is subject to Illinois Income Tax Withholding when the employee has worked in Illinois for more than 30 working days.
Maine Revenue Services announced that, next year, the Governor’s administration will introduce legislation effective for tax years beginning in 2020 to ensure Maine residents avoid double taxation by allowing a tax credit for taxes paid to other jurisdictions if another jurisdiction is asserting an income tax obligation for the same income despite the employee no longer physically working in that jurisdiction due to the COVID-19 pandemic.
Maryland imposes individual income tax on Maryland-sourced income, which is compensation for services performed in the state, without exception.
For March 10, 2020, through December 31, 2020, compensation received for services performed by a non-resident who, prior to the COVID-19 pandemic, worked in state and is now performing services outside of Massachusetts due to the COVID-19 pandemic, will continue to be treated as Massachusetts source income.
Non-resident employees who work for Philadelphia-based employers are not subject to Philadelphia Wage Tax during the time they are required to work outside of Philadelphia.
Rhode Island nonresidents temporarily working outside of Rhode Island solely due to the pandemic will continue to be treated as Rhode Island employees for Rhode Island withholding tax purposes. Additionally, Rhode Island will not require employers located outside of Rhode Island to withhold income taxes from the wages of employees who are Rhode Island residents temporarily working within Rhode Island solely due to the pandemic.
Nebraska will not require a change in income tax withholding for employees telecommuting or temporarily relocated to a work location within or outside Nebraska due to the COVID-19 pandemic, beginning with the date the emergency was declared, March 13, 2020, and ending on January 1, 2021, unless the emergency is extended.
New Jersey has explicitly stated that wages of a telecommuter or a worker temporarily relocated with an out-of-state employer location will continue to be sourced for individual income tax purposes as determined by the employer in accordance with the employer’s jurisdiction. Therefore, no change is required for a taxpayer that has sought refuge in New Jersey as long as the relocation is temporarily due to the COVID-19 pandemic.
Computing Credit for Taxes Paid to Other Jurisdictions
Although states attempt to alleviate double taxation for resident taxpayers through a credit for taxes paid to other jurisdictions, the inconsistency of credit rules among the states may only provide partial relief from double taxation. The credit generally applies only to state taxes, not to taxes by local government or political subdivisions, such as New York City or local counties. It is not always clear whether resident partners or shareholders would receive a credit for entity-level taxes paid by pass-through entities. States such as Minnesota only grant a credit for full year residents, so part-year residents would not qualify for the credit.
States may apply their own nonresident sourcing rules or the rules of the other state as well as different apportionment formulas to compute the credit. A resident credit for taxes paid is limited to the reporting state’s tax liability on the income subject to tax by both states. Thus, employees working in a refuge state with a higher-state tax than the employer state may be subject to higher taxes on those wages earned without an offsetting credit.
As a relevant side note, Arizona recently approved a significant rate increase with a 3.5% surtax on individuals earning taxable income in excess of $250,000 a year or more, or couples earning $500,000 year. The rate increase is effective for tax years beginning on January 1, 2021. This new law increases the Arizona individual income tax rate from 4.5% to 8%, which is now higher than the individual income tax rates in the neighboring states of Utah (4.95%) and Colorado (4.63%).
Additional considerations exist for taxpayers who establish dual residency as a statutory resident in one state in addition to maintaining domicile in a second state. A taxpayer can have only one state of domicile, but they may have lived in several places throughout the year.. Taxpayers may meet the statutory residency test in the 2020 tax year to the extent that they have continued to live and work in refuge states where they own a permanent place of abode and spend more than 183 days or so depending on the respective state rule. Taxpayers must consider whether both states will allow a credit as well as on which state return the dual residence taxpayer should claim the credit. For instance, Minnesota will grant a dual residency credit if the other state does not provide for such a credit. Arizona and Maine specifically allow a dual residence credit.
Convenience of the Employer Rule
The convenience of the employer rule in Arkansas, Connecticut, Delaware, Nebraska, New York and Pennsylvania creates yet another layer of concern for double taxation. And, Massachusetts (a state referenced above) has also passed a similar temporary rule due to the COVID-19 pandemic that is effective through the end of the 2020 tax year.
The convenience rule states that the days that an employee chooses to work from home as a resident of State A, when they still maintain a primary work location at the employer’s office location in State B, would be considered days worked in State B. Thus, the employer would be required to withhold in State B on behalf of the employee working in State A. An exception to this rule applies if the nonresident employee is required to perform work outside State B as a requirement of the employer. Connecticut and Massachusetts are two states that specifically allow a credit for resident employees working in state for an out-of-state employer.
New York only provides a resident tax credit for income that was derived from the other state. This means that the credit would not apply to a resident that works for a New York-based employer generating New York source income based on the convenience of the employer rule. New York State has not yet issued guidance as to whether the state mandated shutdown orders are tantamount to a requirement by the employer for employees to work from home, in which case the days working out-of-state would be allocated as non-New York days. Without clear guidance, New York’s current rules would not grant the relief of a resident tax credit because those wages are considered to be New York days.
An individual taxpayer working for a New York-based employer in March 2020 moves to a vacation home in Colorado to live and work remotely. For the 2020 tax year, the taxpayer files a nonresident Colorado return reporting income for work performed in Colorado on which tax is paid. Colorado nonresidents cannot claim a credit for income taxes paid to another jurisdiction. New York, under the convenience of the employer rule, would consider the taxpayer’s workdays at the Colorado vacation home to be New York days. Colorado nonresidents are taxed on income derived from Colorado sources. Applying a physical presence test, Colorado may deem those wages to be earned from a trade, business, profession or occupation carried on in Colorado subject to tax, therefore, without a resident credit granted by New York, the taxpayer would be subject to potential double taxation.
What if the same taxpayer meets the statutory resident test and files a Colorado resident return? A resident is taxed on 100% of worldwide income, which is generally federal taxable income with certain modifications. Colorado grants a credit for taxes paid to another state on income derived from sources in the other state. If wages earned from telecommuting in Colorado are determined to be earned from Colorado sources, not from sources of the other state, based on a physical presence test, the taxpayer would not qualify for an offsetting credit on its Colorado return. Consequently, the dual resident taxpayer is potentially double taxed on wage income in both New York and Colorado. Furthermore, the New York resident would also be subject to tax on non-wage income without an offsetting credit.
A New York resident taxpayer seeks refuge at a vacation home in Maine and meets the statutory resident test and files a Maine resident return. Maine grants a dual residence credit, provided that the other taxing jurisdiction allows a similar tax reduction. In this case, Maine has announced that it would allow a credit for taxes paid on the wages derived from Maine and subject to tax in New York for Maine residents temporarily working in the state due to the COVID-19 pandemic.
How to Prepare for Telecommuting and Remote Working Taxation
Remote working will continue long after the end of the COVID-19 pandemic that created the expanding need. As a result, taxpayers will face these (and more) complicated state tax issues beyond the 2020 tax year as they continue telecommuting from refuge states into the 2021 tax year, either on a full-time or part-time basis.
By establishing policies for permanent remote working arrangements, employers may be required to change the state in which withholding taxes are paid. Individual taxpayers may need to consider whether they have abandoned their domicile and established a new one. Telecommuting arrangements can create a plethora of state tax issues and considerations for the individual taxpayer, and the employer, that need to be addressed with thoughtful tax advice and planning to avoid unpleasant tax results.