The state and local tax complications around telecommuting are well recognized. However, these issues have taken on an increased prevalence and significance during the COVID-19 pandemic. Questions surrounding state income and sales tax nexus, employee income tax withholding, individual income tax filing requirements, unemployment, and workers’ compensation have only grown since governments began implementing mandatory stay-at-home orders.
Many companies are now facing situations like the following example: A recently hired employee was shipped a computer and a webcam so he could begin working from home. Although your company is located in Seattle, the new employee is still living in Chicago, since he was unable to move before the lockdown began. Other than a few technical issues, things have gone smoothly. But then, your payroll department calls and asks you how he should be set up in your system. Do you need an Illinois unemployment account? Is there a requirement to start withholding Illinois income tax? Is this going to affect the company’s 2020 taxes?
Understanding these questions is a new challenge for many companies now operating with a mobile workforce. This article will discuss how changes in the locations where employees are performing work may affect a company’s:
- nexus footprint,
- state income tax withholding requirements,
- the employee’s obligations for filing state income tax returns, and
- unemployment, disability, and workers’ compensation filings.
Income and Sales/Use Tax Nexus
Let’s start by covering nexus. Nexus is the minimum connection a state must have with a business to lawfully impose and enforce the collection of state taxes under the federal constitution. Most states impose an “economic nexus” standard, which requires a business to pay income taxes and collect sales tax from consumers in the state once the business exceeds certain revenue thresholds. (For an outline of how this recently changed for sales tax purposes, see our article on the USSC ruling in Wayfair).
However, nexus can also be created through the physical presence of an employee working in a state. Thus, having employees working remotely may cause additional sales tax registration requirements for businesses. For income tax purposes, businesses may find they have new or increased income tax liabilities in states that utilize cost-of-performance (COP) based sourcing methodology because of remote employees.
Income Tax Withholding and Filing Requirements
Other complications may arise regarding state income tax withholding and mobile workforces. Generally, states require that income tax is withheld from employee paychecks when the employee is performing work in the state. Some states impose thresholds for how many days an employee must work or how much income they must earn in a state before an employer has an obligation to withhold income tax on the employee’s behalf. These rules can vary widely state to state.
There are also complexities that arise for employees that work in a different state than where they live. Absent a reciprocity agreement, if both states impose a personal income tax, an employee must file two returns, but they will receive a credit for income taxes paid to a nonresident state on the resident state income tax return. Due to the COVID-19 pandemic, many employees will be performing work in different states than they have historically. As summarized here, both employers and employees need to determine what effect that will have on the withholding requirements for the employer and the state income tax filing obligations for the employee.
To further complicate issues surrounding a remote workforce, there are separate rules for determining where state unemployment and disability taxes should be reported and paid or remitted by employers.
Typically, for state unemployment tax purposes, states apply a uniform cascading test to determine where unemployment taxes should be paid. The test is based on where the employee performs the services, the employee’s base of operations, the employer’s direction and control of the employee, and the employee’s state of residence. State disability taxes are typically administered by a separate state agency and have yet another set of rules for employers to work through. Like state income tax withholding, employees working from home in new locations create increased complexity from a state unemployment tax and disability insurance compliance perspective.
How Are States Reacting to These Changes?
Unfortunately, as of this article, there are only a handful of states that have responded to the rise of mobile workforces and released new rules or exceptions for determining nexus, state income tax withholding and filing requirements, or unemployment and disability insurance reporting.
The District of Columbia, Indiana, Massachusetts, Minnesota, New Jersey, North Dakota, and Pennsylvania have taken a position that temporary telework will not trigger nexus for income and/or sales tax purposes. A few states have released statements regarding the effects that temporary telework may have on state income tax apportionment.
The reality that many employees are now temporarily working in different locations than their usual office will create complications and significant exposure in high risk areas for many businesses. If you are concerned about the exposure your business faces because of these changes, reach out to a Clark Nuber SALT professional as early as you can to avoid unnecessary penalties and interest.
Grant Shaver is a senior manager in Clark Nuber’s State and Local Tax team.
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