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October 18, 2022
Tips on Tallying Up State Tax, Withholding Consequences of Remote Work

by Herman B. Rosenthal and Alexander Ashrafi

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One of the most sweeping economic changes arising as a result of the COVID-19 pandemic is the shift from in-person to remote working. Although many employees have returned to working on location again, factors indicate the labor market has evolved to accommodate remote workers more permanently. With the shift comes state tax and other employment issues employers must now confront. This article focuses on some of the state tax issues.

COVID-19’s Ripple Effect

Before COVID-19, certain state tax credits or reciprocity provisions were already in place to account for individuals working in one state while residing in a neighboring state, while multistate businesses “apportion” their income among the states in which they do business based on methods that vary from state to state. Additionally, states through formal or informal policies allowed for varying amounts of de minimis (or very minor amounts of) work within their borders from nonresident workers without triggering tax consequences.

The shift to remote work, however, opens the possibility for employees to work beyond those geographic boundaries for longer periods, thereby creating potential tax consequences in states with which employers previously had little to no contact.

What Employers Must Do

You must take measures to identify where your employees are working and residing to make sure you (1) properly allocate compensation and (2) comply with any income tax reporting and employer withholding requirements in each jurisdiction. Preferably, you can account for employees’ work locations through open and periodic communication with them, though you also can use digital indicators (e.g., IP addresses or payroll software) to keep track of where they’re performing work.

Businesses have noted the ongoing issue of employees not self-identifying their work locations. To remedy the problem, you can encourage employees to be upfront about their remote work. Be sure to affirm the information is required simply for tax and compliance reasons, rather than as an indirect way to discourage them from working remotely.

Other considerations, including employee benefits or the requirements for a business to register or qualify to legally transact business in a given state, also may become relevant with employees working remotely in various states, thereby warranting careful examination of their work locations.

‘Convenience of the Employer’ Rule

States that temporarily changed their tax and withholding rules have already lifted the policies, just as other COVID-19 restrictions and policies are in the process of being lifted.

There’s a broader discussion to be had about how states might rethink their traditional approaches to taxing (i.e., determining whether “nexus” or jurisdiction to tax exists based on the presence of remote workers in the state) and allocating or apportioning income, in the face of the enduring change in the nature and prevalence of remote work. It’s unlikely, however, that states will permanently amend their laws in the immediate future to account for the boom in remote work, which could create tax-related issues for both employers and employees.

For example, New York (along with certain other states) uses the “convenience of the employer” rule, whereby it allows allocation of income to another state with respect to a nonresident employee only if the individual works in that state for the convenience of the employer, not the employee. With the substantial increase in remote, out-of-state work, continued application of the rule has foreseeable problems, such as determining whether any given case of remote work in this new landscape of remote vs. in-person working is necessary for the employer, especially in light of the initial mandates requiring at-home work.

Conflicting State Rules

Additionally, conflicts could arise between two states claiming the same income from a remote employee. Indeed, the issue arose when New Hampshire sued Massachusetts over its emergency rule requiring employers to source wages to the employee’s place of work before the pandemic. Effectively, Massachusetts was claiming the income of employees whose place of employment was in Massachusetts but who were physically working in New Hampshire was earned, and therefore taxable, in Massachusetts.

The U.S. Supreme Court denied it had original jurisdiction to hear the matter, so the issue will likely continue to be litigated in the years to come.

Takeaway

In the meantime, you must learn to adapt to the switch to remote work while the legal framework lags behind. As a result, you must pay close attention to and comply with states’ withholding rules while staying up-to-date on any legal developments in the courts and elsewhere with respect to resolving differing rules among the states.

Herman B. Rosenthal and Alexander Ashrafi are attorneys with Whiteford, Taylor & Preston, L.L.P., in Baltimore, Maryland, and Richmond, Virginia, respectively. Herman is a general tax practitioner with a wide variety of transactional tax planning and controversy experience. He has represented a wide variety of clients in providing practical tax advice, working through complex issues, strategizing with clients and representing clients in audits, administrative appeals and in litigating of tax issues. Alexander is an associate in the firm’s corporate practice. He previously clerked for the Honorable Margaret Goodzeit on the Superior Court of New Jersey.  You can reach them at hrosenthal@wtplaw.com or aashrafi@wtplaw.com.

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