During the height of COVID-19, there were estimates that about half of full-time employees were working from home. Analysts predict that the "new norm" will be working from home and not returning to the office to work. Now, 18 months since the start of the pandemic, some employees who worked from home during this time have returned to the office to work while others continue to telecommute.
This "new norm" arrangement that potentially crosses state lines could create unexpected tax consequences for both the employee and the employer. During the pandemic, some states adopted special rules for telecommuters to ease the tax rules. However, if telecommuting becomes more common, the tax rules set in place prior to the pandemic will likely return.
In most states, state income tax withholding is required based on the state where an employee performs their services. A general rule is a state can tax an employee's earnings if the employee works in the state or lives in the state.
For the employees commuting to a brick-and-mortar location on a daily basis, withholding is generally only required for the state where the employer is located, even if the employee lives in another state. An employee would most likely be required to pay taxes to the state where they work and could have a tax liability in the state where they live, but this doesn't necessarily mean that they would be taxed twice. The state in which the employee lives could give the employee credit for taxes paid to the work state. States that share borders and have a large number of commuters have reciprocity agreements under which withholding is required for the employee's home state, but no tax or withholding is payable to the work state.
When an employee works from home for an out-of-state employer, the home state will usually require income tax withholding if a specific threshold is met. For example, it could be based on time spent working in the home state or based on a combination of time and income.
There are a few states that are not using this method. Some states use a "convenience rule" for employees working out of state for "convenience" rather than their job needs. The convenience rule means the state requires withholding on an employee's earnings based on the employer's location since the employee is telecommuting for their personal convenience.
Arkansas, Connecticut, Delaware, Nebraska, New York, and Pennsylvania applied the "convenience rule" before the pandemic (although Arkansas only adopted the rule in early February 2020). By contrast, the state of Massachusetts adopted a temporary convenience rule in response to the pandemic. Massachusetts' neighbor, New Hampshire, is challenging the rule since many of their residents are employed in Massachusetts but have been working at home in New Hampshire (which has no state income tax) on account of the pandemic.
When an employee works from home in a state other than their employer, it could raise another big issue; nexus. Nexus could trigger state income, sales taxes, and corporate taxes for the employer. If the company is considered to be doing business in the state where the employee is working, a company will have a state tax nexus. Some states are tough on these rules, New Jersey being one of those.
The key point is as these rules and regulations start to loosen up due to employees going back to work, others may still be affected. The employees who continue to telecommute may be liable for taxes in both the state where they "live and work" and where the employer is located. While employees aren't the only ones to be affected, this could also create a nexus situation for the employer.
The Symmetry Tax Engine guides users through a series of questions that helps calculate multi-state taxes. The questions asked allow the STE to utilize multi-state algorithms and determine how the tax engine should calculate the specialized situation. Contact us today to see how the Symmetry Tax Engine can help you!
