Due to the coronavirus pandemic, many employers now have a substantial portion of their workforce working remotely. Accordingly, companies may find themselves with employees working in states where they previously did not have a presence. It is crucial to understand the implications of this from a state and local tax perspective so businesses can develop a strategy for dealing with the issues that will inevitably arise.
Nexus is the level of connection between a jurisdiction and a company that allows the jurisdiction to impose a tax on the company. States have consistently asserted nexus over companies with even one employee working in the state, so companies need to understand the nexus rules of the states in which their employees are working. While states might assert nexus over companies with employees working from home, some jurisdictions have provided nexus relief for companies with employees that are telecommuting due to the coronavirus pandemic; others have not. Once stay-at-home orders are lifted, states may discontinue nexus relief, causing employers to have nexus in those states from which employees continue to telecommute.
Telecommuting employees may cause a company to have to pay income tax in a state for the first time. Federal law protects a company from state income taxation when its only activity in the state is soliciting orders for sales of physical goods. However, having employees telecommute from the state may cause the company to lose this protection. For a company with substantial sales outside its home state, loss of this protection could lead to significant tax exposure.
The presence of remote workers in a state may affect apportionment of a company's income among the states with which it has nexus. Some states look to the extent of the company's payroll in the state to source the company's income, and some states require certain sales to be sourced to the state where the underlying income-producing activity occurs. As a result, presence of a remote worker in these states may change the sourcing of the employer's revenue for state tax purposes.
Withholding obligations on employers can change depending on the remote employee's location. Wages are sourced to the state where the work is performed, so when an employee begins telecommuting, a company's withholding obligations may change. Employers that once had no withholding requirement outside their home state may find themselves subject to withholding requirements in every state from which their employees telecommute. Municipal withholding may be affected as well.
Some states have adopted the "Convenience of the Employer" test. Under this test, compensation is allocated to the employer's location, unless the performance of the work from a remote location is a necessity for the employer rather than to accommodate the employee. The presence or absence of a work-at-home order may affect whether a remote working arrangement is considered to be for the convenience of the employer or of the employee, thereby changing withholding obligations.
The presence of a telecommuting employee in a state or locality may create sales tax collection obligations for sales to customers in that jurisdiction where they did not exist before. Remote employees may also expose companies to gross receipts tax liability in certain jurisdictions. For example, Ohio's Commercial Activity Tax and Tennessee's Business Tax apply to an employer with $50,000 of payroll in the state.
Remote working may affect state unemployment obligations, too. Generally, payroll taxes are paid to only one state, and all states use the same four-part test, which must be applied in the following order:
1. The tax is paid to the primary location of services (i.e., where all or most of the employee's services are performed).
2. If no primary location is discernible, the tax is paid to the state where the base of operations is located (i.e., where the employee ordinarily returns to receive instructions or perform functions relating to the provision of services).
3. If no base of operations is discernible, the tax is paid to the state where the corporate or regional headquarters from which the employee receives instructions is located.
4. If none of the three tests above provide an answer, the tax will be attributed to the employee's state of residence.
Employers must also obtain workers' compensation insurance in the state to avoid penalties for noncompliance.
The coronavirus pandemic has shown that a remote workforce may be a feasible option for many businesses. However, it is critical for employers to understand the tax implications of any remote work arrangement. A failure to do so may lead to additional tax exposure or unwanted compliance obligations.
Grassi is a member of McDonald Hopkins LLC.
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July 18, 2020 at 03:00PM
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Tax Tips: Understanding state, local tax implications of remote work during the pandemic - Crain's Cleveland Business
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