When COVID-19 began, no one envisioned how long remote work would last or if people would want to continue working remotely permanently. Along with the many challenges this created in the workplace, the most important issue is how remote workers pay state and local taxes. In general, there is a difference between employees who work remotely because of their employers’ necessity and those who do so for their own convenience. With hybrid work arrangements becoming a feature of the new workplace, employers should be very deliberate when they communicate and execute policies relating to an employee’s work location.
Convenience of the Employer Rule
The core question is: Which state does the employee pay income tax to: the state where they live or state where their employer is located? In most states, a remote employee must pay taxes wherever they reside. However, some states follow a “convenience of the employer” rule that treats days worked at home as days worked at the employer’s location if the employee is working remotely for their own convenience and not the employer’s necessity.
Some states have reciprocal agreements stating that employees only have to pay tax in the state where they live, no matter whether they are doing so for necessity or convenience. Employees in this category will only have taxes withheld for one state.
If the employee lives and works in different states and those states do not have a reciprocal agreement, the employee will have to file two tax returns, one for each state. In addition, some cities and localities, such as New York City and Yonkers, New York, have their own taxes, which means some taxpayers will have to pay taxes to three entities.
While taxpayers affected by these rules will not necessarily be double- or triple-taxed because they usually are eligible for tax credits, each state has its own tax rates, and that could affect the taxpayer’s total tax bill.
This issue may eventually reach the U.S. Supreme Court, but the court recently declined to hear two cases relating to telecommuting tax policy.
Domicile or Residency
A person’s state of domicile is the state in which their primary residence is located. A person has statutory residence in a state if they spend more than 183 days in that state in a given year. Some people also have income from additional states.
In general, personal income taxes must be filed in the state where the taxpayer’s principal residence is located. This is true for both W-2 employees and 1099 independent contractors.
Keep in mind that even states that do not collect personal income taxes usually require the taxpayer to file a return, and taxpayers who live in one of those states must file nonresident tax returns in states from which they receive a W-2.
Keeping relevant documents and records, including utility bills and EZ pass statements, can help support your claims if you are audited. Having a daily calendar can be helpful as well.
Employer Considerations
Remote workers can cause additional work for employers, which must be sure to be compliant with payroll tax withholding rules for accurate payroll tax withholding and reporting. Business tax filings may also be affected, including filings regarding pass-through business income, unemployment insurance withholding, workers’ compensation, disability, sales tax, and employment requirements.
Particularly, sales tax can be an issue since it takes only one employee working in a state to create an economic nexus in that state.
There are many rules to consider, including how long COVID-19 rule suspensions or modifications will be in force. In many instances, these rules have either expired or will expire shortly.
To avoid any penalties, individual taxpayers need to be familiar with the tax law in their resident state and businesses should be aware of tax laws in all states they operate.
Speak with a tax accountant or CPA to navigate this changing area of the tax law.