Some states have been proactive during the pandemic, issuing temporary guidance including waiving nexus and even revising apportionment rules.
With many states reopening in various phases while others are rolling back, businesses are facing new challenges surrounding tax consequences of employees working remotely after months of COVID-19 lockdowns. During the pandemic, employers have been looking to states to provide guidance on a myriad of issues, such as nexus (a connection between a taxing jurisdiction and an entity, which creates income, withholding and sales tax obligations) in new states, determining proper state tax withholding and employment tax obligations.
The pandemic has caused employers to face new obstacles, particularly when employees work in states or local jurisdictions other than where the employer has presence. As a result, nexus and associated tax impacts will eventually move beyond neighboring states.
Although approximately a dozen states have provided waivers and special guidance, many taxpayers lack clarity as to whether the presence of telecommuting will be treated differently during and beyond the lockdown. The handling of telecommuting has never been dramatically tested and is so uncertain that we may see federal legislation to standardize state rules for nexus and withholding, or to force states to revise current rules.
New Nexus Normal
The “new normal” of employees working remotely over an extended period of time may have lasting impact. Physical presence could be established in a new state for some businesses with simply a single employee working from home, let alone an entire workforce working remotely over many jurisdictions. The presence of an employee in a new taxing jurisdiction could create nexus for the employer for income and franchise tax, sales and use tax or other business taxes. This may result in filing obligations that never previously existed. Depending on the apportionment rules for the applicable taxing authority, the increase in payroll within the new jurisdiction could increase the amount of income or capital apportioned to the state, resulting in greater tax exposure and, ultimately, additional tax liabilities.
With employees working from home for weeks or months, states may enforce their nexus rules aggressively, and the chances of audit may increase significantly. In addition, some employees may establish nexus in a local jurisdiction that has its own gross receipts or income tax, such as New York City or Philadelphia.
Some states have been proactive during the pandemic, issuing temporary guidance including waiving nexus and even revising apportionment rules. For example, New Jersey waived its rule treating the presence of employees working in remote locations or in their own homes as sufficient nexus for out of state corporations. New Jersey also issued guidance that it will not assert sales tax nexus for employees working from home in New Jersey for out of state employers during the pandemic. In addition, Pennsylvania will not seek to impose corporate net income or sales and use tax nexus solely on the basis of temporary work activity of employees, including telecommuting from their Pennsylvania home, for a business that otherwise does not have nexus in Pennsylvania. Other states and jurisdictions, such as the District of Columbia, Indiana and Mississippi, announced that employees working remotely from their state will not establish nexus for their employers during the pandemic. Also in Mississippi, employees working remotely will not affect income tax apportionment for their employers. Other states that have adopted similar rules include Alabama, Georgia, Iowa, Maryland, Massachusetts, Montana, Nebraska, North Dakota, Rhode Island and South Carolina.
Some states are taking a lenient approach to employee nexus during the pandemic and resulting lockdowns. However, the longer telecommuting continues after orders are lifted and the deeper the state budget deficit, the more likely leniency may wane and the less accommodating states and tax jurisdictions may be.
State Tax Withholding
Regulations outlining withholding tax requirements for employees working within their jurisdictions vary among states. Factors such as reciprocal agreements between states and convenience of the employer rules determine employer withholding obligations.
States such as New Jersey, Pennsylvania, Massachusetts, Georgia and South Carolina have issued guidance to employers to maintain withholding for employees who normally work within their state but are now temporary working in other jurisdictions. Furthermore, Maryland, Illinois and Massachusetts have also relaxed business withholding obligations for telecommuting employees.
In some cases, reciprocal agreements between states will determine the withholding jurisdiction. For example, Pennsylvania and New Jersey have a reciprocal agreement that eliminates wage-sourcing issues for employees shifting work locations between both states as there is an agreement not to tax the wages of a resident of each state.
Telecommuting also affects localities with their own income tax withholding obligations. Recently, Philadelphia issued guidance stating that nonresident employees of Philadelphia employers are not subject to the city’s wage tax for the time they are required to work outside the city. In addition, Ohio recently passed legislation that provides a safe harbor and establishes that the days spent at home teleworking in an Ohio locality during the pandemic won’t count toward the state’s 20-day threshold for withholding local income tax.
While some have issued guidance, many states still have not indicated whether they will apply different withholding and employment tax rules to COVID-19 related telecommuting. Also, many businesses may not have modified their withholding during the lockdown due to the suddenness of the mandates issued during the pandemic.
Employers that fail to withhold for employees open themselves up for penalties and interest assessments, and in some cases liability for taxes that they have failed to withhold.
Some states, such as New York, with convenience of employer rules (which require state income tax withholding by in-state employers for nonresident employees working out of state for convenience rather than necessity) may be challenged in court as an unnecessary convenience in the future. The distinction could play a vital role in determining whether employers in those states must withhold for telecommuting employees. Other states with convenience of employer rules include Connecticut, Delaware, Nebraska and Pennsylvania.
Beyond the Lockdowns
The lockdowns ordered in response to COVID-19 have brought to the forefront a myriad of different state tax rules for telecommuting. Additionally, the displacement of employees during the pandemic could accelerate changes in work patterns and pressure states to adopt tax policies that are more accommodating for mobile workers and are more uniform regarding how telecommuting employees affect employers’ nexus and withholding requirements.
However, it is unclear if states, which are dealing with significant revenue losses due to the pandemic, will move in the direction of modernizing business tax codes to better align with teleworking and multistate business plans.
State and local jurisdictions are in budget crises, are facing sharp declines in tax revenue and may look for ways to raise revenue including higher taxes, new taxes and expanded audits. Meanwhile, challenges continue within this COVID-19 environment, including safety, health and rapidly changing state tax guidance. We continue to monitor state and local legislative activity to determine the impacts of actions taken in state houses.
While it is expected that many state and local jurisdictions will continue to grant some relief, it is important to take careful note of those that do not, as margins of relief narrow due to budget shortfalls. Businesses and their workers might find themselves with additional state and local tax obligations as a result of the location of their employees and will need to act accordingly to remain in compliance.
For Further Information
If you would like more information about this topic or your own unique situation, please contact Michael R. Bartosik, Steven M. Packer, any of the practitioners in the Tax Accounting Group or the practitioner with whom you are regularly in contact. For information about other pertinent tax topics, please visit our publications page.
Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.