State and Local Tax Considerations for Remote Employees
When the COVID-19 pandemic started, no one could have envisioned how long remote work would last or how many people would want to continue working remotely on a permanent basis. Along with the many problems this created in the workplace is one that affects 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 this: Which state does the employee pay income tax to: the state where he or she lives or the state where his or her employer is located? In most states, a remote employee must pay taxes wherever he or she resides. 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 his or her 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 his or her primary residence is located. A person has statutory residence in a state if he or she spends 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 that 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.
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 passthrough business income, unemployment insurance withholding, workers' compensation, disability, sales tax and employment requirements.
Sales tax can be a particularly thorny 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 be sure to avoid any penalties, individual taxpayers and businesses need to be familiar with the tax law in their resident state and any other states in which they operate. Getting professional help is the best option for navigating this changing area of the tax law.
Our firm provides the information in this e-newsletter for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. The information is provided "as is," with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.
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