First, will the presence of an employee working from home create taxable nexus for the employer in that state?
Second, for income tax purposes, which state is owed income tax when an employee is telecommuting from an out-of-state location? Is it possible that states could have contradictory rules, creating a double tax situation for many employees? (Spoiler alert: yes!).
To help track this, we put together a chart that outlines how states have responded to these two telecommuting issues. We’ve been updating the chart as new guidance is released, and we’re relying on Checkpoint’s survey of and responses from all 50 states for a lot of the guidance. Click here for the chart. Here’s a summary of each issue:
Will nexus be established by a work-at-home employee?
The term “nexus” generally refers to the nature and frequency of contacts that an out-of-state company must establish in a state before it becomes subject to that state’s tax laws and jurisdiction. Some level of minimal contacts with the state is required under the U.S. Constitution before an out-of-state company is subject to the state’s tax laws. And for sales tax purposes, physical presence is no longer required after the U.S. Supreme Court decision in South Dakota v. Wayfair. With the nexus threshold so low, most states have said that the presence of one to six telecommuters in the state would give rise to an income tax filing obligation for an out-of-state company.
Our analysis highlights that the growing number of states that have issued guidance saying that the presence of a telecommuting employee in the state, if her presence is a result of COVID-19, will NOT create nexus with the state. Some states have explicitly stated that this applies for purposes of corporate income tax nexus, as well as sales tax nexus.
What state gets to tax the work-at-home employee’s wages?
For personal income tax purposes, most states have the rule that the employee’s physical presence dictates where tax is due. So, for example, an employee working from his Michigan home for his employer in Illinois is required to pay Michigan income taxes, since he is physically present in Michigan doing work. Pre-COVID, there were six states that imposed a “convenience of the employer” rule that treated days worked-at-home outside the state as days worked in the state for purposes of determining nonresident withholding and personal income tax obligations. These states included New York, Delaware, Nebraska, Pennsylvania, and Arkansas, which eliminated its convenience rule this year, and also Connecticut, which applied the rule (effective 2019) only on a reciprocal basis, i.e., if the taxpayer’s home state employed the rule. Under the “convenience of the employer” rule, if the employer or the employee’s principal office is located in one of those states, then the employee’s compensation earned while telecommuting will be treated as if earned in the employer’s location, and not from the state in which the employee is telecommuting, if the employee is working remotely for her own convenience and not the employer’s necessity.
So what happens in situations where an employee is working from his or her home in another state during COVID? Some states have decided not to change the employee’s income tax obligations (and/or the employer’s withholding obligations) based on the employee’s temporary work in their home state—meaning that the tax will still go to the employer’s state, i.e., the state where the employee regularly worked, pre-COVID. But others have said that they will continue to apply the physical-presence rule and impose tax on an employee who is working from home. And of course, this sets the stage for some pretty terrible double-tax results for employees and employers who straddle two states, who both want their tax.
