COVID-19 started a revolution in remote work arrangements. Initially, workers were forced to work from their homes because of government-mandated shutdowns. Then, workers continued working remotely because of preference. Due to the tight labor market, many employers have agreed to this work arrangement to retain their staff and hire new workers. There are certainly many benefits to a company in supporting remote work—the ability to hire talent wherever located, offering a valued employee benefit, and downsizing company space to save money. But there are some added tax problems for employers having remote workers.
Some added tax problems for employers to recognize:
State business taxes
If a company does business in a state, it must register and is subject to state income taxes. Doing business means having a “nexus” to the state. What constitutes “doing business” is often an issue and the answer varies from state to state. For example, in New Jersey, a state court said to a company in the software development business incorporated in Delaware with its office in Maryland that having one employee based in New Jersey—a software developer working from home who was supervised by a manager who telecommuted from Massachusetts—meant the company was doing business in New Jersey. New Jersey uses a 5-factor test to determine whether a company has a nexus there:
- The nature and extent of the activities of the corporation in New Jersey;
- The location of its offices and other places of business;
- The continuity, frequency and regularity of the activities of the corporation in New Jersey;
- The employment in New Jersey of agents, officers and employees;
- The location of the actual seat of management or control of the corporation.
Other states have their own criteria for determining whether there’s a business connect that triggers tax obligations. What’s more, states have their own methods of allocation to determine how much service receipts are sourced to a state, which affects how much revenue is subject to tax where the company is located and where it is also treated as doing business. Rules are inconsistent, with some states more aggressive than others.
Withholding taxes for employees
When an employee lives and works in a state that’s different from where the employer is located, things can get complicated. Here are some basic rules:
- Generally, the employer must withhold income tax in the state where work is performed. But if there is a reciprocal tax agreement among the states involved, withholding can be made for the employee’s state of residence rather than in employer’s state.
- If an employee who resides in another state works exclusively in that state which is different from the employer’s state, then taxes are usually withheld only in the employee’s state.
- If an employee works a few days in each location, the employer must withhold income taxes in each state where the employee works. Where there is a tax differential because one state has higher income taxes than another, the employer may have multiple withholding responsibilities. One state is viewed as the primary taxing state; the other is the secondary taxing state.
Pandemic era relief
During the pandemic, some states provided relief to employers from nexus. For example, Massachusetts enacted a law stating the presence of one or more employees working remotely in Massachusetts due to COVID-19 pandemic did not, by itself, create a withholding obligation with respect to such employees, nor subject the company to a sales and use tax collection obligation or to the corporate excise tax (or corporate apportionment adjustments). But this relief expired on September 13, 2021. Other states had similar relief, which has also expired, some as recent as March 2022. Find a list from KPMG.
It’s important for businesses continuing remote work arrangements to understand fully the implications for tax purposes. For example, determine whether a company is obligated to offer certain benefits (e.g., paid family and medical leave) to remote workers where the benefits are mandated in their location even though there’s no such mandate where the company is located. Work with a knowledgeable tax professional to help do long-term planning if you intend to continue with remote work arrangements.