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Do You Have Remote Employees? Understand the State Tax Implications

Businesses should know what tax pitfalls to look out for when dealing with their digital workers.

With many business leaders forecasting that remote work is here to stay, full remote work or hybrid telecommuting arrangements will likely be commonplace. The state and local tax effects of telecommuting range far and wide, from business income tax and sales tax to payroll tax. It’s crucial that businesses understand the potential state tax pitfalls of having employees working remotely from other states.

Income Tax and Sales Tax Implications

With corporate income tax or sales tax, the impact of nexus is very apparent. For a jurisdiction to impose a tax, it is required that a sufficient connection exists. Traditionally speaking, a business establishes nexus when an employee is physically working from that state. Although a tax authority may provide limited exceptions to this, such as an employee working from home, an employee whose activities are de minimis (i.e., immaterial day count) or COVID-19 relief, these exceptions are few and far between. In fact, effective Oct. 1, 2021, New Jersey’s COVID-19 waiver of income and sales tax nexus no longer applies.

With states generally imposing widespread economic nexus provisions, physical presence is not even a requisite to establish nexus for many businesses. A business with economic nexus, absent of any exceptions (i.e., P.L. 86-272 federal law protection), will nevertheless find itself with a filing imposition. At the very least, the remote employee may increase audit risk detection for noncomplying businesses.

With business income taxes, the reverberations of telecommuting with respect to state tax apportionment could be as consequential. While many states have shifted away from the traditional three-factor formula to a single-sales factor, many states still use payroll in computing state taxable income. Remote employees may dictate how businesses compute state apportionable income due to a variable payroll factor. As a result, businesses should not overlook these effects, as even an apportionment increase of a couple of percentage points could result in a significant tax impact.

Possibly even more significant are states that still retain cost of performance (COP) sourcing for computing the sales factor of apportionment. For service businesses subject to COP sourcing, such as the New York City’s Unincorporated Business Tax (UBT), which sources income from services by the place where the services are performed, there may be an opportunity to significantly reduce entity-level UBT taxes as more employees work from home in the suburbs. This contrasts with New Jersey’s provision, which sources sales based on the office at which its personnel (e.g., employees, independent contractors) are situated or connected to.

Payroll Tax Withholding Implications

Another area that has garnered significant attention is payroll taxes. Mainstream news media covered New Hampshire’s lawsuit against Massachusetts regarding taxation of New Hampshire residents who normally had worked in Massachusetts, but who were working remotely during the pandemic.

Effectively, Massachusetts put in place a “convenience of the employer” rule, albeit temporarily. Traditionally speaking, a convenience of employer rule treats wages as state sourced for an employee assigned to the employer’s office, unless the work was performed outside the state at “the necessity of the employer,” as opposed to for the convenience of the employee. Employees may find themselves in the unique situation where they could be subject to tax in two states: the state they are working remotely in and the state of their employer’s office. Adding to this confusion are COVID-19 relief, reciprocity states, convenience of employer rule exceptions, and credit for taxes paid considerations. Considering the lack of uniformity across states, these rules have created a lot of havoc for payroll tax administrators.

There has been a significant uptick in businesses and people moving to states with more favorable business climates. However, the tentacles of state tax can be far reaching, and it’s essential that employers understand all of the implications so they can engage in proper tax planning and put safeguards in place to mitigate any unintended tax consequences. This includes evaluating current operational models for nexus mitigation and apportionment optimization, developing remote workforce policies, and implementing employee tracking procedures.

About the Author:

Jason Rosenberg, CPA, CGMA, EA, MST, is a senior manager in the state and local tax practice at Withum. He is the vice leader of the New Jersey Society of CPAs State Taxation Interest Group. He can be reached at jrosenberg@withum.com.

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