Effects of multistate teleworking arrangements on state taxation
The COVID-19 pandemic has had a profound impact on the economy, our daily lives, and “business as usual.” In addition to the new modalities of mask-wearing and Zoom-schooling, large segments of the economy have transitioned to a mass telework model that had not otherwise been contemplated prior to March 2020.
As millions of workers continue to settle into new routines, entire industries and state taxing authorities alike must consider the potential state tax implications of an entire workforce shifting, suddenly, to a telework model. Significant complexities affecting multiple layers of state taxation could arise absent state intervention or proper tax planning. It’s critical that government contracting business leaders and owners be cognizant of these key issues arising from the pandemic.
With many employees no longer working at their assigned office locations, every business should evaluate its new footprint. Very likely, one or more employees (if not significantly more) may now be working across state lines beyond the company’s pre-pandemic boundaries. If so, the business needs to consider whether the presence of those employees could trigger physical presence nexus (i.e., a sufficient presence to warrant a tax filing obligation) in new jurisdictions.
It is generally accepted that telecommuting employees can create nexus on behalf of a foreign or out-of-state corporation for state tax purposes. For example, in 2012 a New Jersey court decided in Telebright Corp. v. Director that one employee working full-time from her home in New Jersey developing software code for her employer in Maryland was sufficient to create income tax nexus. What happens if an employer’s entire workforce is redeployed to multiple locations, including new states, other than the employer’s workplace? Without proper consideration and planning, this could create a host of costly new tax compliance obligations and inequities.
As of mid-September, sixteen states and the District of Columbia had released guidance addressing taxation concerns arising from multistate COVID-19 telework disruptions. Click below to access our reference tool summarizing aspects of that guidance.
New Jersey, for example, was quick to issue guidance indicating that it would temporarily waive corporate income tax nexus thresholds as a result of telecommuting due to COVID-19. Similarly, Minnesota issued an FAQ indicating that it would not seek to establish nexus for any business tax “solely because an employee is temporarily working from home due to the COVID-19 pandemic.” The District of Columbia issued a notice stating that it would not seek to impose corporation franchise tax or unincorporated business franchise nexus solely on the basis of employees or property temporarily located in the District during the public health emergency.
On Sept. 11, the California Franchise Tax Board issued guidance stating that it would not treat an out-of-state corporation as doing business in California for income tax nexus purposes if the corporation’s only connection to the state is the presence of teleworkers due to COVID-19 under the governor’s “Stay at Home” Order (Executive Order N-33-20). Further, California will treat the presence of these teleworkers as de minimis for purposes of P.L. 86-272 protections.
Other states may follow suit and provide guidance given the significant uncertainties already presented by the pandemic. Nevertheless, government contractors and their leaders need to begin assessing their state and local tax risk arising from employees working remotely from states where they previously had no income tax filing obligations.
If pandemic-related workforce changes create nexus in new jurisdictions, then a business needs to consider the impact upon its multistate apportionment of business income. While nexus determines whether a state can impose tax, apportionment determines how much income is subject to tax. For states that utilize payroll and property factors, the presence of employees or company property in a new jurisdiction may impact the apportionment formula. In addition, a company that, as a result of COVID-19 disruptions, establishes nexus in a new state in which it happens to have high in-state sales volume may have a significant new tax liability if that state utilizes a single sales factor apportionment formula.
Furthermore, advisors should consider whether a company’s sourcing of receipts may be impacted. In states that utilize cost of performance sourcing for sales revenue, a shift in workforce location could potentially affect the location where services are performed. For states that utilize market-based sourcing, if the customer is no longer located where the employer’s traditional workplace is, it is conceivable the market state (where the receipts would be sourced) may have changed.
Payroll withholding and income sourcing considerations
Generally, employers are charged with withholding income taxes based upon the location where an employee works, which may be different from the location where the employee resides. For example, a New York employer would typically withhold New York wages for employees working from its New York office; this is true whether the employee resides in New York, New Jersey, Connecticut, or Pennsylvania.
Under COVID-19-related disruptions, many employees may now be working from their home state – or perhaps from an altogether new state, if they chose, for example, to shelter in place with family or at a vacation property. This reassignment of work locations raises employer and employee compliance concerns. Several states have released guidance addressing this issue. Again, New Jersey was quick to issue FAQs indicating that during the pandemic, “wage income will continue to be sourced as determined by the employer in accordance with the employer’s jurisdiction.” Mississippi issued a press release stating that during the coronavirus national emergency, it “will not change withholding requirements for businesses based on the employee’s temporary telework location.” Maryland issued a tax alert stating that its withholding “requirements are not affected by the current shift” to telework, but it also conceded that it will recognize the “temporary nature of a business’ interim workplace model and employee deployment” in light of the pandemic.
Businesses must further consider the impact of state reciprocal agreements, such as the New Jersey/Pennsylvania agreement or the Maryland/Virginia/D.C./West Virginia/Pennsylvania agreement, among others. Under these compacts, states often agree not to tax residents of the other state(s) on sourced income. As such, telework arrangements may not matter for income allocation and withholding purposes where reciprocity agreements are in place.
Furthermore, both employers and employees should consider the potential impact of state “convenience of the employer” rules. Under these rules, days worked from an employee’s home state (if different than the state of employment) for the employee’s “convenience” as opposed to the employer’s “necessity” may be re-cast and treated as days worked from the state of employment. New York and Connecticut, among a few other states, are notable in their use of these rules to recapture work-from-home days. Significant complexities may arise as bus and subway commuters become telecommuters working from home outside of New York City, for example.
Lack of guidance and the potential for complexity ahead
Absent clear guidance, the movement to mass telework has the potential for significant complexity ahead. If the presence of teleworkers in new jurisdictions can create nexus on behalf of employers, leading to an array of new compliance obligations, including payroll tax, income tax, and others, then companies must begin now to evaluate these issues in an effort to prevent foot faults and missteps from wreaking unforeseen havoc later.
As our reference tool indicates, significantly fewer than half of the states have published any guidance addressing these issues. Furthermore, many of the states that have granted some degree of relief have done so only for an undefined temporary period. Only a handful have provided a certain date indicating when the relief will expire.
For example, South Carolina has indicated that an out-of-state business with employees temporarily teleworking from there due to COVID-19 will not be subject to South Carolina withholding, nor will that out-of-state business be subject to South Carolina nexus, but this relief currently expires Dec. 31, 2020. Similarly, Oregon has indicated that employees temporarily teleworking from within the state due to COVID-19 will not create nexus for the employer, but this relief currently expires Nov. 1, 2020. Further, Oregon has not issued guidance indicating its position with respect to employee payroll withholding.
With varying degrees of relief expiring at different times, or without any clarity as to when relief, if provided, may or may not apply, businesses are confronted with a degree of uncertainty that is sure to cause frustration and consternation.
Moreover, the uncertainty is not limited to just taxpayers, but also affects tax administrators. For example, a border battle is brewing between New Hampshire and Massachusetts over these very issues. Unlike Massachusetts, the state of New Hampshire does not impose an individual income tax. Prior to the pandemic, tens of thousands of New Hampshire residents were daily commuters into Boston and surrounding Massachusetts communities. Since March, many of those workers have left their cars in the garage and have shifted to teleworking from their living rooms located in New Hampshire. Massachusetts, however, has issued a rule attempting to continue to impose tax on those nonresident workers as if they were continuing to work within Massachusetts. In turn, that has prompted New Hampshire’s elected leaders, including Gov. Chris Sununu, to challenge Massachusetts’ actions, which he says have raised “serious policy and legal concerns with Granite Staters being taxed in Massachusetts when they have not crossed the state line in months due to the COVID-19 pandemic.” Sununu has been quoted in the media as accusing Massachusetts of trying to “pick the pockets” of New Hampshire.
The above are just a few of the more common questions and issues confronting taxpayers, but there are many others. Physical presence nexus may also trigger sales tax and gross receipts tax concerns, among other tax compliance burdens. If a business could be determined to have nexus as a result of COVID-19 telework arrangements, should it take steps to affirmatively register with the new state? Does it have workers’ compensation, disability, and unemployment insurance obligations in the states where its employees are now working and performing services on its behalf? Are there personal income tax residency implications for individual employees?
Further, the longer the pandemic continues, there undoubtedly will be many employers and employees that become accustomed to, and some who prefer, telework arrangements. Indeed, many employers have already adopted policies contemplating telework arrangements that will continue for many months, well beyond existing government shelter-in-place mandates. Businesses and tax advisors should be careful to understand the distinction between having telework forced upon them due to a public health crisis and making business decisions that empower employees to continue telecommuting from new states – and accept that such decisions will create nexus and related compliance obligations.
At this point, there are more questions than answers. Businesses, business leaders, tax advisors, and state policymakers should continue to examine these issues. Companies must evaluate their telework footprints and track the locations of their workforce. In what states are employees conducting activities now? Is that new footprint expected to continue, and for how long? Companies need to be vigilant and should monitor the states for additional guidance. Contact our team to discuss these issues.
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