As more states are extending their COVID-19 shelter-at-home orders into the summer months, businesses may be operating remotely longer. The logistics of allowing employees to work from home can be difficult, given the increased demand on IT infrastructures alone, but complying with state and local tax laws will also be a challenge.
Income and Sales Tax Considerations
If your employees are forced to work from locations other than the locations where they typically work, even temporarily, your business will likely generate nexus in those states. “Nexus,” or the sufficient connection you have with a state before you become subject to its taxing laws, is almost always triggered by physical presence. Even employers with remote employees that previously had the protection of P.L. 86-272 may no longer qualify for that protection, if remote employees now engage in unprotected activities. State nexus laws have become more aggressive (especially since the South Dakota v. Wayfair Supreme Court case of 2018), making it unlikely that an organization with physical presence will be exempt from state or local income tax. Further, employees working from home may impact the employer’s state income tax computation (particularly in states that still apportion income to the state using a payroll factor).
Nexus laws in most states have not been updated to give consideration to the unforeseen COVID-19 “state of emergency/stay at home” orders. Only a few states, including Massachusetts (TIR 20-5) and Rhode Island (ADV 2020-24) issued guidance confirming that employees that previously worked in another state, but are now working remotely from home in Massachusetts and Rhode Island, due solely to COVID-19 restrictions, will not create nexus for income or sales and use tax purposes.
Jurisdictions that impose a personal income tax on employee wages typically require employers to withhold tax from wages earned by an employee that either resides in the jurisdiction or performs services in the jurisdiction. Employees that now telecommute from a location other than the one in which they typically work may cause employers to have a withholding obligation where they previously didn’t have one.
State payroll and income taxes are overseen by different departments, so check with the state’s Department of Labor to fully understand your payroll obligations if you have remote workers. You will likely need to do two things: Take note of when your employees began working remotely and the city/state where they have been working. (Note that some localities also impose income or business licenses taxes). If any of your employees have been working out-of-state, mention your nexus concerns to your tax advisor so they can help you determine next steps, such as:
- Filing payroll tax returns in any new states/local jurisdictions (to report state-specific items like unemployment taxes and disability insurance, and head taxes), and
- Withholding income taxes from your employees working in those new jurisdictions.
Some states have reciprocal agreements that alleviate tax burdens on employees and lessen filing requirements for employers. If reciprocity exists, an employee can elect to be exempt from taxes in the state where they work and instead only pay taxes in the state they reside.
Some states, including Massachusetts, have issued guidance that special treatment will be applied to employees during the COVID-19 period. Compensation paid to non-residents who immediately prior to the COVID-19 state of emergency worked in Massachusetts will continue to be treated as Massachusetts employees. Compensation paid to these non-residents will continue to be subject to personal income tax in Massachusetts, regardless if they are working outside the state, solely due to the COVID-19 state of emergency. Massachusetts residents now working from home in Massachusetts, due solely to the COVID-19 state of emergency, and continue to incur income tax liability elsewhere, will be eligible for a credit for taxes paid to that other state. As such, employers in this scenario would not be required to withhold Massachusetts income tax to the extent it withholds income tax elsewhere on those affected employees.
Payroll taxes have notoriously high penalty and interest rates, so act quickly. Your tax advisor can help you set up new payroll reports in your time clock system and apply for payroll licenses in other states if needed.
Rules Might be Changing for COVID-19
Just as the federal income tax payment and filing deadline were pushed back due to the COVID-19 pandemic, many states delayed their state income tax filing and payment deadlines to July. However non-income state tax obligations, such as withholding, may not have changed, so it is important to note the states in which you may have obligations so you can plan accordingly.
In addition to the comments above, regarding Massachusetts and Rhode Island, other states that have opted to waive certain nexus requirements for telecommuters during the COVID-19 crisis include the District of Columbia, New Jersey, and Pennsylvania.
Remote workers may create income tax nexus, apportionment, and payroll tax implications. Taxing authorities typically look for recordkeeping to track which employers are working from home versus coming into the office, but given all that’s going on during the COVID-19 pandemic, many states are offering relief to this level of recordkeeping. It is going to be very difficult for employers to track new state and local tax obligations that might arise during the remote work situation. Working with a state and local tax advisor may help with monitoring the various extensions and relief measures available for 2019 and 2020 taxes.
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Tarra Curran is a Managing Director and Leader of the New England State and Local Tax Practice. She can be reached at firstname.lastname@example.org or 401.626.3240.
Ann Brown is a Senior Tax Manager in the New England State and Local Tax Practice. She can be reached at email@example.com or 617.761.0658.
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