For years, remote workers had been complicating state tax compliance for companies. When the U.S. Supreme Court’s decision in Wayfair came out in June 2018, many believed that the decision’s economic nexus standards would reduce complexity surrounding remote workers. But the COVID-19 pandemic has had a profound impact on how and where we work. And so remote workforce issues have become as problematic as ever. Employers are finding that they need to make careful decisions about whether and how much to allow their employees to work remotely. This post identifies several major considerations that employers should evaluate before letting an employee work from another state.
Residency of Employee
When employees ask employers to work remotely, they are typically either planning to move to another state by becoming residents there (an increasingly common phenomenon as described in our previous blog posts here and here) or opting to work from other states for shorter periods of time without changing their residency. Thus, the first step in analyzing the implications of letting an employee work from another state is confirming where that employee is or will be a resident.
Once the state residency status is confirmed, the employer will need to withhold income tax (if applicable) and register for unemployment insurance for that employee in the employee’s resident state.
If an employee is requesting to work from another state or states where that employee will not be a resident, then the employer may also need to withhold income tax for that employee in such states, but on a nonresident withholding basis as described in greater detail below.
When employees request to work from states where they are not residents, the employer may need to withhold income tax from them on a nonresident basis. Unfortunately, determining when nonresident withholding is triggered varies significantly from state to state. According to the Mobile Workforce Coalition, “employers are required to incur extraordinary expenses in their efforts to comply with the states’ widely divergent withholding requirements for employees’ travel to nonresident states for temporary work periods.” See Mobile Workforce Coalition, Problem, available at https://www.mobileworkforcecoalition.org/ (last accessed on Nov. 6, 2021).
To demonstrate the range of thresholds, the Mobile Workforce Coalition has prepared a map. It shows that more than half of the states trigger withholding for nonresidents on the first day that an employee is in the state. Some states trigger withholding for nonresidents based on an income threshold (e.g., $1,500 in wages in Wisconsin). Other states require withholding once an employee has worked in a state for a certain number of days (e.g., between 2 and 14 days, between 15 and 29 days, or greater than 30 days).
The primary exception to nonresident withholding obligations arises from state reciprocity agreements. When an employee who is a resident of one state works in another state with which the first state has reciprocity, nonresident withholding may be unnecessary, subject to the terms of the interstate reciprocity agreement. For example, Minnesota currently has reciprocity agreements with Michigan and North Dakota. Under these agreements, if a Minnesota company has an employee who is a resident of Minnesota, but who works in Michigan or North Dakota, and returns to Minnesota at least once a month, then nonresident withholding for Michigan or North Dakota would not be required for the employee.
Employee Individual Income Tax Obligations
Employees should also be aware that working from another state may trigger nonresident individual income tax consequences and personal requirements to file nonresident state income tax returns. Again, in many states, the employee-level thresholds for nonresident state income tax obligations are completely different from the thresholds for employer-level withholding obligations (e.g., New York). As noted by the Mobile Workforce Coalition, “[e]mployees who travel outside of their states of residence for business purposes are subject to onerous administrative burdens because they may be legally required to file an income tax return in every other state into which they traveled, even if they were only there for one day.” See Mobile Workforce Coalition, Problem, available at https://www.mobileworkforcecoalition.org/problem (last accessed on Nov. 6, 2021).
Employer Exposure: State Tax Nexus Implication
And as if the above wasn’t convoluted enough, there are potential state tax implications for employers who allow their employees to work from states where that company has not historically filed sales/use tax or income tax returns. By permitting an employee to work from such states (on either a resident or a non-resident basis), the employer will likely activate “nexus” with those states for the company itself. Further, the presence of remote workers in those states may negate company nexus protections like Public Law 86-272. Having nexus with a state may require the company to file income tax, sales tax, and other potentially applicable tax returns.
Compliance Burdens and Risks
Strict compliance with all of the above requirements (especially the nonresident withholding thresholds) is extraordinarily difficult. And it is an arduous task to keep track of where employees are working (including their “day counts”) and to analyze how those day counts interact with the cornucopia of state nonresident withholding thresholds and the nexus consequences of allowing telecommuters. Further, approaching these issues on an ad hoc basis carries quite a bit of risk. For example, if the employer fails to properly withhold, that employer could be responsible for back taxes, penalties, and interest. If the employer is unable to pay those back taxes, penalties, and interest, states may issue personal liability assessments to individuals at that company who were responsible (or should have been responsible) for the decision not to withhold.
It is, therefore, important for companies to be thoughtful in how they approach these issues. Employers should consult an experienced advisor who can help them understand the risks and consequences of remote work arrangements and help them frame policies that make sense from both a business perspective and a tax perspective.
Her experience includes resolving and litigating numerous types of tax disputes:
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