For many business owners, adapting to a pandemic and post-pandemic workplace means accommodating remote employees. When your employees’ home office is in a different city or state, there are tax implications that you should be aware of.
Teleworking employees may create state and local tax (SALT) liabilities depending on where they earn their compensation and for how many days per year they work in a different state than their employer.
Generally, a state taxes income earned in its state. If an employee works outside the state where his or her employer is located, there is a chance he or she could be subject to income taxation by both states.
During the pandemic, many states offered temporary relief to taxpayers to avoid this scenario, and many issued guidance on pandemic-related remote work arrangements relative to which state—the employer’s location or the employee’s location—would collect income tax.
Also, some states have “convenience-of-the-employer” rules, which allow employers to treat out-of-state compensation as if it were earned at the employer’s location. (See “Income Tax” section below.)
States that have lost tax revenue due to the pandemic are eager to recoup what they can. Taxing out-of-state workers is one way to potentially make up for lost revenues, and now that declared states of emergency are largely past, the compliance grace period for SALT is ending.
While many companies had systems in place pre-pandemic to track traveling employees’ days in various locales, few were concerned with where the rest of their employees worked. COVID changed that. Living and working in two tax jurisdictions means that employers and employees must pay attention to resident and nonresident income tax withholding rules.
For people working as “nonresidents” in a state, income tax withholding is required only on the wages earned in that state. However, the convenience-of-the-employer rule—which assumes the employee is working out of state for the convenience of the employer—means that some states will tax income not earned in the state. This “double taxation” is often offset by a tax credit in one state or the other, but that is not always the case.
It may take states some time to reach a final resolution about this withholding issue relative to COVID. For example, employees had no option but to work remotely in response to “stay-at-home” mandates, so where does convenience of the employer enter the discussion? In most cases, this issue is still unresolved.
You may have heard or read the term “nexus” extensively in the last two years as businesses and governments tackle the changes in the pandemic work environment. It refers to the connection between a taxing authority and the entity that pays taxes — and those relationships have become more complicated as more companies adopt remote work arrangements.
States have given leeway during the pandemic to businesses with remote employees, but as remote work becomes a more permanent fixture, states are going to be more proactive about collecting tax dollars. Absent any new federal legislation, this will mean added tax complexities for businesses of all sizes.
Like any area of tax law, taking a proactive approach to remote work and nexus is the best way to reduce your tax exposure and filing headaches. That means establishing a trusted relationship with a tax advisor who knows the complexities of SALT and can position your company for success. Contact Dembo Jones today.