8 minute read 15 Mar 2021
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How alerting employees to unintended tax traps helps companies, too

By Michael Goldsmith

Partner, Ernst & Young LLP EY US East Region Indirect Tax Services Leader

Michael is an experienced state and local tax professional who has worked across a broad range of industries, including technology, professional services, media and entertainment, and manufacturing.

8 minute read 15 Mar 2021

US organizations are finding that remote working can be just as risky for the business as it is for their employees.

In brief

  • State tax laws on remote working vary widely, posing risks for the unwary.
  • Employees must keep the company updated on their work location and relocation plans.
  • A robust remote worker policy includes input from the company’s tax, legal and HR departments.

During the early days of the pandemic, when New York was at the epicenter, health care workers nationwide showed up to work on the front lines. After returning home, they were surprised to learn that the state of New York expected them to pay nonresident income taxes on the wages they had earned while working there.

While New York is one of the most robust states in the battle for remote workers’ tax dollars, there are several other states where that might have happened. Across the US, remote workers and their employers could be in for similar surprises if they’re not careful.

Little time to prepare for the switch to remote working

When COVID-19 arrived in the US, companies didn’t have months to plan their response, they had hours or, at best, days. Tech giants led the pivot to widescale remote work. In March 2020, many of the largest tech companies began encouraging employees to work from home; some made it mandatory. Nearly a year later, of the 58% of Americans currently employed, 42% have worked remotely during the COVID-19 pandemic, according to an October 2020 Harris Poll survey of 2,053 adults.

Remote working may have begun as a temporary situation, but for more than 2 million companies, it’s here to stay. Most recently in the tech sector, we have seen announcements that some companies are adopting remote working on a permanent basis.

With so many people working remotely, companies and their employees need to know the tax implications of where individuals are living and working — and even where they’re planning to move. But more than half (55%) of employees who have worked remotely during the pandemic weren’t aware that a failure to change their state tax withholding to reflect their remote work situation could result in tax consequences, according to the Harris survey.

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1

Chapter 1

How can you be in two places at once?

Varying state tax laws mean employees risk double taxation; their companies face related risks.

Unfortunately for remote workers and their companies, there’s more to managing risk than remembering to change your withholding. Because each state has its own tax laws related to remote working, and because state and local budgets are lean these days, employees and their companies risk falling into an unintended tax trap.

Know the issues

Most companies and employees assume that remote workers are working from home. And that if you’re a remote worker, you’ll owe taxes to the state where your home is, assuming your state has personal income taxes.

But it’s important to know that, generally, there are two ways a state might classify a person as a resident:

  1. Domiciliary: The person has a permanent residence in the state and intends to remain there.
  2. Statutory: In many states, the person is considered a resident if they’ve spent more than six months there.

Many remote workers become statutory residents without even realizing it. As previously noted, New York state takes a robust approach to taxing remote workers. The state classifies a person a resident if they spend 183 days there and also have a permanent place of abode there. However, the state’s definition of one day is not 24 hours. If one were to cross into the state for a haircut and then leave 90 minutes later, that is a day, by New York’s classification standards. And “permanent place of abode” is a place, owned or rented, where the worker can live — for example, an apartment.

Exposure to double taxation is a very real threat for hapless remote workers. Consider a young professional who is sharing an apartment with friends in New York City but decided to shelter with relatives out of state during the pandemic. Not only will New York potentially tax her as a resident, based on domicile, but the state where she’s sheltering might also consider her a resident for tax purposes.

The employee’s company also faces a potential risk. If she’s sheltering in place in a state where the company doesn’t already have a presence, she could be creating a tax filing responsibility for the company, subjecting it to the taxes of that jurisdiction, taxes that might not otherwise apply.

Tax credits and safe harbors

Remote workers may receive a nonresident tax credit in their state of residence to offset the tax they’re required to pay the state in which they’re working. Additionally, some states have been providing a temporary safe harbor for state withholdings and tax liability for remote work performed in a different state during the pandemic. Some states have also temporarily waived the creation of a business nexus. However, lean state budgets suggest that these protections won’t last indefinitely; certain states have already lifted the emergency legislation or are seriously considering doing so.

Convenience or inconvenience?

Before the pandemic, 400,000 New Jersey residents were commuting to their jobs in New York. When those commuters stayed home to shelter in place, New York continued to tax their wages, applying the “convenience of the employer” test. Generally, under this rule, the source of the income is the employer’s location, where the individual worked prior to the pandemic.

Several states apply this test, but New York has spearheaded its application, issuing detailed guidance on its use. Roughly 15% of New York’s tax revenues are from out-of-state commuters, which explains the state’s stringent enforcement.

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Chapter 2

Will the Supreme Court weigh in and issue a landmark decision?

At issue: whether states can tax income of nonresidents working remotely for in-state businesses.

COVID-19 has left states with severe budget shortfalls — and in a battle for remote workers’ tax dollars. The December 2020 federal stimulus package did not include money for state and local budgets. But the newly approved $1.9 trillion relief package includes $350 billion for state, local and tribal government assistance.

In the meantime, the fight for tax dollars continues. New Hampshire, filing a case directly in the Supreme Court, is seeking to protect its citizens from an emergency regulation that Massachusetts enacted in response to COVID-19. Under the regulation, nonresidents who worked in Massachusetts before the pandemic but are now working outside the state still have to pay its 5% income tax. It’s worth noting that the emergency measure has been repeatedly extended.

The case is important nationally, because it would determine the right of a state to collect income tax from nonresidents working remotely for in-state businesses. It’s possible the Supreme Court will hear the case, because it recently issued an order inviting the acting Solicitor General to file a brief that expresses the views of the United States. Fourteen states have sided with New Hampshire in amicus briefs.

Enticements to move

The shift to remote working has given millions of employees the opportunity to move. They now have the option to move from cities such as San Francisco, Seattle and New York City to less-expensive locales, where homes are more affordable. And US states and cities vying for this newly unmoored tech talent are making some intriguing offers. Examples include:

  • Natchez, Mississippi: ~$6,100
  • Tulsa, Oklahoma: $10,000
  • Northwest Arkansas: $10,000 and a bike or free membership to cultural activities
  • Savannah, Georgia: ~$2,000 in moving expenses

Organizations should be prepared for the possibility of an increasing number of employees who are relocating, or plan to relocate, to another jurisdiction.

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Chapter 3

How can employees and their companies protect themselves?

Avoiding unintended tax traps requires diligent recordkeeping and a thorough company policy.

Employees and their companies can reduce their exposure to risk by taking the right steps. One of the smartest things an employee can do is to keep the company’s human resources department apprised of their work location.

If there’s a plan to move to another state, the company needs to know that as well. Keeping the company updated protects the employee, as well as the company. If a company isn’t withholding correctly, the employee could face penalties.

Because time spent in another state can have unintended tax ramifications, employees need to keep clear and thorough records of where they worked and for how long. They should check the tax laws for the state or states in which they work and the state where their company’s office is located.

One of the best ways for companies to protect themselves and their employees from tax risks is to have a true and whole remote worker policy (RWP). A strong, protective policy will have a decision-making team that includes professionals from tax, human resources and legal departments. The rules should be clear to everyone who looks at the policy, from the C-suite to the first-year staff members.

It’s estimated that by the end of 2021, 25% to 30% of the workforce will be working from home several days a week. And just as each state and local jurisdiction has its own set of rules on wage taxation, each worker has a unique set of facts and circumstances. The onus is on companies to exercise extreme diligence in their monitoring and recordkeeping.

While the pandemic fueled the move to remote working, something else is driving its widespread adoption on a permanent basis: organizations’ need to remain competitive in the quest for talent. But with so many unintended tax traps for the unwary, companies also need to protect the employees they’ve already got — and, in the process, themselves and their leadership.

Summary

The ranks of remote workers are expected to exceed 25% by the end of 2021. Companies must continue to offer that flexibility to remain competitive in the quest for talent. But they also must take the steps necessary to protect themselves and their employees from unintended tax traps for the unwary.

About this article

By Michael Goldsmith

Partner, Ernst & Young LLP EY US East Region Indirect Tax Services Leader

Michael is an experienced state and local tax professional who has worked across a broad range of industries, including technology, professional services, media and entertainment, and manufacturing.