The COVID-19 crisis has brought major changes to the U.S. workforce. Many employers have transitioned their workforces to remote work. Now, employees can work from anywhere with an Internet connection. Many employees have taken advantage of the flexibility by investing in home office spaces, moving to different states, and even traveling the country. What most employees and employers haven’t considered, however, are the unique and complex income tax issues that have arisen with a remote workforce.
Understanding State Income Tax Scheme
Generally, an employee’s home state can tax her income regardless of where the money is earned. She also can be required to file a tax return in her state of employment if different from her home state. In other words, employees may be required to elect tax withholding and file tax returns in both their home state and the state of employment. There are various exceptions to the general rule.
In the age of COVID-19, employees and employers that traditionally didn’t have to worry about the general rules of state income taxes between states may be blindsided by both the employer’s and the employee’s new tax situations:
- Some commuter employees who reside in State A and commuted to work in State B before the pandemic now work remotely in State A. They may no longer have income tax obligations in State B.
- Others who worked and lived in State A have decided to relocate temporarily to State B, meaning they could be subject to tax withholding and filing in both states, depending on their situation.
Employers are left helping employees to navigate their specific income tax withholding obligations and reconciling the company’s tax obligations.
Potential Employer Impacts
As remote work continues and likely becomes a regular part of business operations for the foreseeable future, you need to be aware of the potential effects caused by employees’ telework habits and locations:
State tug-of-war over taxes. Currently, many states have issued temporary guidance essentially maintaining the “status quo” method of state income taxation for nonresident employees working inside their borders. As states struggle with budget shortfalls, however, the temporary status quo will likely end, and employers and employees will be stuck in the middle of the battle for revenue.
Lawsuits are currently underway between states over the potential tax revenue. The cases are in the early stages, and the outcome is far from certain. Nevertheless, the litigation raises legitimate constitutional questions about states’ ability to tax employees working beyond their borders.
New tax-filing obligations. You could potentially face additional business and employment tax-filing obligations as a result of remote employees working in a state in which your company doesn’t otherwise have a physical presence or other nexus. Depending on the various states’ tax schemes, you could potentially be required to alter unemployment insurance withholding, worker’s compensation, and disability insurance based on the duration and location of an employee’s remote work.
Business tax nexus in new state. Next, remote employees may cause you to acquire a business tax nexus in a state where you traditionally had no substantial link. Having a nexus would subject your business to income and sales tax within that state. Prolonged remote work also has the potential to affect business income tax apportionment. Unless there’s temporary guidance, a shift in labor costs (e.g., payroll) could change how you’re required to apportion income in states in which labor costs are a key factor.
Disqualification from incentive programs. Finally, if your company benefits from existing state or local incentive programs or agreements, you need to critically evaluate remote employees’ impact on the specific job creation or employment requirements. Remote work may disqualify your company from the incentive programs.
Bottom Line for Employers
You must recognize the potential risks inherent in allowing employees to choose the location and duration of their remote work. As we wait for permanent state-specific guidance and the conclusion of the state lawsuits, you should consider paying close attention to tracking employees’ remote work locations to ensure accurate payroll tax withholding and business tax filings as much as possible.
Next, consider reviewing your remote work policies and their interaction with state tax laws. Depending on the state’s tax policy, there can be a difference between whether you require remote work or allow it for employee convenience. As you begin to reopen your offices, you should strategically evaluate the implication of making the office available to employees on a periodic basis. For the above reasons, you should continue to monitor state taxation developments and the impacts on your workforce.
Emily R. Selner is an attorney with Axley Brynelson, LLP, in Madison, Wisconsin. You can reach her at 608-283-6791 or eselner@axley.com.