With millions now working remotely as a result of the COVID-19 pandemic, it’s not unusual for a company’s workforce to be spread across several states. It’s one of the ways companies are being flexible and creating a more flexible and safe working environment for their employees. Unfortunately, confusion over how states tax those workers has created traps for the unwary on both the individual and entity side, with the latter being the focus of this article.
Even the most seemingly innocuous acts can prove costly for both corporations and individuals. For example, one employee can unintentionally drag the entire company into a state in which the company doesn’t file taxes, simply by inadvertently neglecting to inform the company about the move into a new state.
A New York-based business experienced this firsthand. The company has a presence, and files on a corporate level, in 25 states. One of its employees moved to a new state but didn’t tell the company. This presented a major, and unanticipated, problem for the business, because the employee’s new residence was not in one of the 25 states that the company files in. Because of one employee’s mistake, the company found itself with a presence in a 26th state and exposure to significant adverse tax consequences.
“Convenience of the employer” rule
C-suite executives risk exposure on both fronts — as individuals as well as for the company that they are employed by. In March 2020, as people across the US were starting to grasp the gravity of the pandemic, a chief financial officer for a Fortune 100 company whose home office is in New York City sought advice on his decision to work remotely. He planned to move to his home in Utah and to start withholding as a Utah resident.
What might appear to be a reasonable and prudent course of action would have likely exposed the CFO to double taxation. Why? Because New York applies a “convenience of the employer” test, one of those aforementioned traps for the unwary. Under the rule, all income earned by a nonresident working for a New York employer is taxable by New York state unless the income was for work performed outside of the state for the necessity of the employer, rather than out of convenience.
The convenience rule was challenged in court, in what proved to be a seminal case, Huckaby v. New York State Division of Tax Appeals. The case addressed a Tennessee resident who was employed by a New York company but spent only 25% of his working time in New York state. The New York Court of Appeals upheld that 100% of the employee’s income was subject to taxation by the state of New York.
Applying the Huckaby test, all of the CFO’s income would be taxable by New York state, because he would be working from Utah for reasons of his own and not because his employer deemed it necessary.
When we look at the CFO not as an individual but as an employee of the company, the risks expand. Suppose the CFO’s solution were to tell the company in New York to stop withholding on him as an employee. This would expose the company to significant underwithholding risk — particularly now, amid the economic devastation caused by the pandemic. The states are increasingly likely to pursue strict enforcement of their withholding requirements in an effort to close large budget gaps. And state auditors, thinking in terms of economies of scale, will choose to look through a company’s payroll system rather than to pursue thousands of individuals separately. Ultimately, directors and officers risk exposure to direct liability if the corporation can’t meet its obligations. Moreover, there is potential reputational risk and brand damage to the company.
States vie for the same tax dollars
Massive budget shortfalls have states battling each other for the right to tax remote workers’ income, with billions of dollars at stake. The $908b federal stimulus bill that Congress signed into law at the end of December 2020 does not include money for the states. However, Congress apportioned $160b for state and local aid in a package that has not been voted on yet.
The states’ clashes escalated in October 2020, when New Hampshire filed a petition with the U.S. Supreme Court to stop Massachusetts from taxing the income of New Hampshire residents who commuted to their jobs in Massachusetts before the pandemic but now work from home. More than a dozen states joined the fray in late December 2020, submitting briefs on behalf of New Hampshire.
This lack of uniformity among the states has caused a level of confusion that creates risks for businesses and individuals — risks that have increased with the rise of remote work. And although Congress has acknowledged the need for clearer rules regarding interstate taxation disputes, there is no federal legislation. In fact, several state tax commissioners have urged the federal government to pass legislation governing this issue. Until such legislation is passed, there will continue to be conflicting state positions that inevitably leave individuals and companies subject to the risk of double taxation.
At the start of the pandemic, many states enacted “safe harbor” emergency legislation that waived business tax nexus for COVID-19-related remote work. But some have begun lifting the legislation, and more are likely to follow suit as the pandemic wears on and monetary effects worsen.
A policy for protection
Companies are still playing catch-up when it comes to protecting themselves from the risk of exposure inherent in the quick pivot to remote working on such an unprecedented scale. Surprisingly, of more than 100 companies seeking insights on the matter, none was utilizing what is perhaps the most effective protection from exposure: a true and whole remote worker policy.
An effective remedial work plan (RWP) must involve a clear set of rules. It must be reasonable, and it must apply uniformly. The solution should plainly illustrate clear ties between employees and an appropriate mapping of offices and states. Policy decision-makers should include professionals from the Tax, Human Resources and Legal departments. For an organization to create a strong, protective policy, all three must have a seat at the table. Whether the employee is the CFO or a first-year staffer, the company should be able to point to the policy and show the set of rules that was applied and the answer that resulted.
Although companies’ widespread shift to remote work began as a strategy to keep employees safe, many companies are adopting it on a permanent basis to remain competitive in the quest for talent. Now, as the nation attempts to adjust to this new reality, company leaders should have a strategy that includes a remote worker policy to keep entities safe as well.