Working from home, or telecommuting has become a standard work practice amidst the coronavirus pandemic. Employers with employees who are working in states other than the state in which the company is physically present must be aware of a variety of problems related to nexus and income tax which can arise as a result. Each state has different laws regarding nexus, de minimis exceptions, income tax, and withholding requirements.
Nexus is the connection that an out-of-state company must establish in a state before it becomes subject to that state’s tax laws and jurisdiction. Most of the time, physical presence is not needed, and each state has its own provisions defining what activities will create nexus for a business.
Employees may now owe income tax in their state of residence as well as in any jurisdiction where they have worked. This creates the need for employers to track the employee’s work locations to determine withholdings. Employees can also have state and local tax obligations, even if the employer is not required to withhold.
To prevent double taxation, some states use the ‘convenience of the employer’ test to source wage payments. These states include but are not limited to Arkansas, Connecticut, Delaware, Nebraska, New York, and Pennsylvania. Under this rule, if an employer is located in any of those states or the employee’s principal office of their employer is located in any of those states, then wages earned while working at home will be treated as if earned in the employer’s location within those states, as long as the employee is working from home for his or her own convenience and not the employer’s convenience.
Other states use the physical presence standard, in which the employee is taxed where the work is physically performed. In some cases, where states follow different standards, it may be possible that the resident’s state credit for taxes paid to another state will not cover the nonresident state taxes paid.
Thirteen states including Alabama, Georgia, Illinois, Indiana, Massachusetts, Maryland, Minnesota, Mississippi, Nebraska, New Jersey, Pennsylvania, Rhode Island, and South Carolina have followed the AICPA’s suggestion about providing guidance. These states allow businesses to continue withholding income tax in the state where the employer is located and allow the employee who is temporarily telecommuting to continue paying to the state where the employer is located.
In addition to the 13 states above, the District of Columbia and the city of Philadelphia have followed AICPA’s recommendation that an employee working remotely in a state due to restrictions would not create nexus and apportionment for tax purposes. Five states including Georgia, Indiana, Iowa, Massachusetts, and Rhode Island have stated that workers who have recently started telecommuting as a result of pandemic restrictions will not count against companies taking P.L. 86-272 positions, which prevents states from imposing net income taxes on an out-of-state company if the company’s activities in the state are only restricted to the “mere solicitation” of sales of tangible personal property, and the orders are sent outside of the state for approval and fulfillment.
The current and future climate will have short and long-term state and local tax implications for both businesses and their employees as multi-state taxation is still evolving, and states are issuing more guidance. Sciarabba Walker will keep our clients updated as future guidance is issued.
If you have any questions, please reach out to your personal Sciarabba Walker contact or email us at firstname.lastname@example.org.
Written by Svetlana Svetlichnaya, CPA