Posted by Shivali Anand
November 9, 2021 | 4-minute read (668 words)
Although the COVID-19 pandemic has allowed many people to work from practically anywhere, it has also created tax compliance concerns for some companies and employees. The underlying cause? Every state in the U.S. has its own regulations for taxing remote employees and the businesses that employ them.
The result is that some companies with employees who live and work in states other than where the business is located may be hit with unexpected state and local taxes. Meanwhile, remote employees who relocate to lower-tax areas may find themselves taxed twice on the same income.
Some employees face double taxes
Income is normally taxed by the state in which the employee works or resides while earning their pay. Due to a lack of regularity in how that rule of thumb is applied to remote work situations, state income tax regulations have proven nebulous in some cases.
State income taxes for remote workers fall into three types:
Some states are unwilling to let go of taxes on revenue once generated within their borders. They have resorted to taxing newly out-of-state workers based on the business's unchanged location.
Even if the resident has temporarily relocated out of state for their convenience and does not work in the state, these states continue to tax remote employees based on their employer's office location.
In many circumstances, the so-called “convenience rule” also disqualifies employees from receiving tax credits in their home state, resulting in double taxation as two governments attempt to tax the same income.
Connecticut, Delaware, Massachusetts, Nebraska, New York, and Pennsylvania are among the states that have adopted this convenience rule.
- States that follow the rule of convenience
Certain states in the mid-Atlantic and Midwest have developed tax agreements with adjacent states to avoid taxing workers twice. Virginia and the District of Columbia have mutual tax agreements. Employees who work in Washington, D.C., but live in Virginia file taxes in their home state instead of Washington, D.C.
Washington, D.C., and these states have reciprocal agreements: Arizona, Illinois, Indiana, Minnesota, Montana, New Jersey, Iowa, Kentucky, Maryland, Michigan, North Dakota, Ohio, Pennsylvania, Virginia, West Virginia and Wisconsin.
- States with mutually beneficial partnerships
For the time being, 15 states, including Alabama and Georgia, have opted not to tax employees who moved in temporarily during the COVID-19 pandemic.
Employers using remote work settings may be subject to state income taxes
Employers may also be subject to one or more of the following six unforeseen state taxes stemming from remote work.
Wrinkles in withholding: Many states, but not all, have published guidelines on corporate income tax withholding obligations. However, the measures used by the states that have created such guidelines are not always obvious. If the requirements overlap, a single employee's income tax withholding may be triggered by more than one state, increasing the employer's withholding responsibilities.
Employee-tracking systems: Companies also must establish systems to track where their employees are, in addition to dealing with new state tax requirements. Developing and executing a procedure for tracking an entire staff is a new problem, even if many firms already had established standards for traveling personnel.
Additional corporate taxes: Employers may be subject to additional taxes due to the nexus formed by out-of-state workers. The employee creates a physical nexus while working outside the state or states where the company operates, requiring the employer to comply with the tax systems of the relevant states. Businesses may face additional state income taxes, franchise taxes, gross receipts taxes, and sales and use taxes, for example.
Employment and labor laws: Employers from out of state may be required to follow labor and employment regulations in the state where a remote employee works. Workers' compensation insurance, pay and hours, and unemployment insurance may be affected.
Business registrations: Employers may be required to seek a certificate of authority to lawfully do business in states where they earlier had no operations or personnel working due to the existence of new remote workers there.
- States exempting temporary residents from paying income taxes