Businesses Must Know Where Workers Are to Minimize Out of State Tax Headaches by Karen A. Lake, CPA, CFST
Posted on July 01, 2020
Businesses that were forced to close their offices and send employees home to work remotely during the COVID-19 pandemic must consider how those actions may impact their state and local tax payment and reporting obligations. Just one employee telecommuting from a state outside his or her usual work location may be enough to trigger a nexus, or sufficient commercial connection, that can expose both employer and employee to that state’s unique tax regime.
State governments hungry for tax revenue often look beyond their borders to exert some degree of taxing authority and reporting compliance over businesses that have a physical or economic connection to their states. At the most basic level, nexus is created when a business has a physical presence in a state, such as a brick-and-mortar office or store, inventory, or the presence of telecommuting employees working from their homes. Additionally, businesses must contend with state tax laws requiring income tax obligations based on economic nexus, which can be triggered by such things as a business’s sales volume into those states.
Under normal circumstances, businesses can prepare for the tax implications of these nexus-creating activities and the variations in tax laws for determining taxable nexus that vary from one state to the next. However, these are not normal times. The current health crisis and immediate disruption to normal business operations have eliminated any opportunities taxpayers may have had to preplan for potential nexus in states where they did not previously have any taxable presence. Consequently, businesses must take the time now to assess whether employees telecommuting from a different state than they would typically work, even temporarily, could create a nexus for income tax, sales tax and/or employment tax purposes.
For purposes of determining a business’s liabilities for state-level income tax and withholding tax from workers’ wages, states will typically look at where employees physically perform their work. In fact, some jurisdictions already have laws in place specifying that telecommuters working from their home states do create taxable nexus for their employers, whereas other states have tied their taxing authority to various tests that measure a business’s sales, property and/or payroll in those states. The wide range of testing thresholds from one state to the next further complicate businesses’ attempts for efficient tax planning, especially in the current business environment.
Thankfully, some U.S. states have already acted to temporarily waive corporate income and payroll tax obligations on out-of-state businesses whose workers have been forced to telecommute temporarily from those states during the COVID-19 pandemic. As of June 2, these states include Alabama, the District of Columbia, Georgia, Indiana, Iowa, Maryland, Massachusetts, Minnesota, Mississippi, New Jersey, North Dakota, Pennsylvania, Rhode Island, and South Carolina. Some of these states have even extended the remote work nexus waiver to cover employers’ income tax apportionment.
However, businesses should tread carefully to understand all the nuances of these state waivers and their related tax-filing and payment responsibilities, as the details may vary from one state to the next.
For example, guidance from Pennsylvania and Massachusetts imply that employers in those states should continue to withhold tax on wages paid to their usual in-state employees who are now working remotely from other states. By contrast, Maryland will consider compensation paid to nonresident workers telecommuting from the state to be state-sourced income subject to withholding.
Among the remaining states, some, including Texas, have indicated that they will evaluate the nexus-creating impact of teleworkers on a case-by-case basis. New York will allow employers in the state to designate employees teleworking from out of state during the pandemic to be performing their work in their usually locations for state and local tax purposes, including apportionment. In Illinois, the only relief offered to out-of-state businesses with employees teleworking from within the state for more than 30 days is a waiver of penalties and interest for failing to withhold Illinois income taxes due to COVID-19.
When it comes to state income taxes, it is best for businesses to err on the side of caution, maintain accurate records to support their positions and seek the counsel of experienced state and local tax advisors.
About the Author: Karen A. Lake, CPA, is a state and local tax (SALT) specialist and an associate director of Tax Services with Berkowitz Pollack Brant, where she helps individuals and businesses navigate complex federal, state and local tax laws, and credits and incentives. She can be reached at the firm’s Miami office at (305) 379-7000 or firstname.lastname@example.org.