Is Interstate Teleworking a Tax Trap?
Originally published on October 25, 2021
Updated on October 27th, 2023
It’s becoming clear that teleworking is no longer a temporary measure to reduce the spread of COVID-19. With some employers seeing no drop in productivity (and even some gains) with remote workers, companies are choosing to allow the practice to continue even as pandemic protocols drop.
As a result, teleworking is becoming a valuable tool for retaining employees who are reluctant to return to the office. It’s also being used to attract high-quality job candidates no matter where they live.
With the emergence of teleworking, however, comes new wrinkles in state and local tax (SALT) obligations. States have varying laws on how employees’ wages are taxed and how company nexus is established. If you have an employee working in a state other than where you primarily do business, they can be subject to income tax in those jurisdictions—leading to potential double taxation issues. They can also open your company up to additional tax obligations in those states.
“Convenience of the Employer”
Long before the pandemic, the convenience of the employer (or COE) test has been used by states to extend their tax jurisdiction to teleworkers employed by companies in their state but living in other states. It’s used to determine whether such employees are subject to income tax in the state in which the company does business rather than the state they’re working in. As a result, employers are then only required to withhold on teleworkers in the company’s state.
Some states have a long-standing practice of using the COE test; New York, for example, adopted the test nearly 50 years ago. Others only recently introduced it during pandemic-related circumstances, when teleworking arrangements increased. For example, Massachusetts’ emergency regulation adopted a temporary COE test under which a nonresident who teleworks outside the state is deemed to be working at the in-state location of their employer unless the nonresident teleworks out of necessity and not just the employer’s convenience.
With the increase in teleworking due to the COVID-19 imposed lockdowns, many states provided tax guidance through their emergency orders. These orders addressed how companies should consider nexus and withholding during the uncertain times.
Some states reiterated their existing convenience of the employer rules. However, some states (such as Rhode Island) adopted a new COE-type test with the following goals in mind:
- Maintaining pre-pandemic tax bases
- Mitigating employers’ withholding compliance obligations
- Limiting additional tax obligations a company may now face with an employee working in the state
Most states indicated that they would temporarily relax their nexus rules as a result of the mandates. That meant employers and employees could be less concerned with new state tax obligations, including withholding and filing requirements. These temporary protections also addressed other tax obligations that result from a physical presence in the state.
A New Kind of Tax Limbo
To make teleworking and tax matters more confusing, many state and local governments have indirectly lifted some of their tax guidance through the expiration of emergency work from home orders and states of emergency.
Some states have also altered their COE tests. For example, Arkansas enacted a law in April 2021 that removed the COE test it had initiated in February 2020. Under the new law, nonresidents earning income from Arkansas sources will only pay tax on the income earned while physically present in Arkansas when performing the work.
As states relax such orders and modify their rules, however, employers are left in limbo. Are they and their employees now bound to new SALT obligations if employees remain remote? What is the status of these protections if emergency orders are no longer in effect?
On May 27, 2021, the Multi-State Worker Tax Fairness Act was introduced to Congress. Much like the Arkansas law, this bill would only allow states to impose income tax on the compensation of nonresidents when they’re performing work while physically present in that state.
At the writing of this article, the bill is with the Senate’s finance committee. States are also battling with each other to protect their residents from potential double taxation as a result of some of these changes. Aside from these developments, not much is known about the future of teleworking and individual SALT income tax issues.
States have also indicated a return to audit examinations, which may shed light on their approach to nexus and additional tax liabilities. One thing is certain; it is important that employers know where their employees are located. But with each state having its own thresholds for tax nexus, every employer-employee situation may yield different tax results.
With so many variables, we recommend speaking with a CPA team dedicated to state and local tax issues. By tracking each state’s regulations and the latest developments on teleworking and taxation, they’ll bring you the most updated information.
All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a James Moore professional. James Moore will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.
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