During the pandemic, state income tax rules evolved as employees worked from home. Therefore, employers should review their state and local employment tax and nexus policies to best handle remote workers.
Employee Taxes
When employees telecommute, state income taxes and sales tax compliance issues arise. For example, some states have a convenience rule requiring employers to withhold tax from employees who work out of the state, even if the employer doesn’t have a physical presence there. It is risky for the employee and employer because it can lead to double taxation.
Similarly, some states require employees to pay self-employment (SE) tax on their earnings, whether from home or in the office. Generally, these workers are responsible for filing their SE tax returns in the state of residence. Again, this change may call into question the satisfaction of statutory jobs credits and negotiated incentives based on the number of jobs created or retained in a given state.
For businesses located near state borders and employing remote workers, these issues can impact state income, gross receipts, sales, local business taxes, financial statement reporting, registrations, and data gathering. In addition, prolonged remote work may also affect how businesses apportion taxable revenue in states that use payroll and receipts factors and the sourcing of tangible goods and service revenue for those that follow a market-based sourcing methodology.
Employer Taxes
For many employers, the pandemic has created a new world of remote work. And while some employees may have found the unique flexibility to be a positive change, it could also have remote work tax implications.
If your firm operates in a state where sales taxes are levied, having an employee working remotely from another state can trigger that jurisdiction’s nexus rules and create a liability for the business to collect and remit that tax. It can be a particular issue for organizations with multiple locations or those with many sales in the same few states.
Some states have a rule known as the “convenience of employer” test, which means that if your organization has an office in a state and you send an employee to work from home in that same state, the company must withhold the local state’s taxes.
Other states that require apportionment of income may not consider temporary changes in an employee’s work location to impact their company’s gross receipts or franchise tax factor, but this is something that you should check with your state tax advisor—remembering that the same is not valid for pass-through businesses and their owners are essential.
Tax Withholding
As a taxpayer, you have some experience with withholding tax: the money your employer withholds from your paycheck throughout the year and sends to the IRS on your behalf. It helps the United States maintain a pay-as-you-earn income tax collection system and prevents taxpayers from receiving big, unaffordable tax bills at filing time.
State and local tax rules can complicate matters further, especially if employees straddle multiple jurisdictions during the pandemic. Generally, employees are taxed by the state where they live and work. However, extensive remote work during the pandemic may cause employees to become subject to the income tax rules of two or more states if those states follow different rules for telecommuting workers.
Some states have tried to resolve this issue by enacting laws that treat all employees working from home during the pandemic as residents of their resident states. It is an effective solution for employees, but it can create problems for employers operating in states that use a physical-presence standard and have many nonresident workers.
Sales Tax
As the pandemic continues, remote work becomes a permanent part of business operating and hiring models. But, unfortunately, with it comes a host of state and local tax implications.
A remote employee’s activity may trigger income, gross receipts, franchise, and sales taxes, depending on the state. It can also impact the sourcing of service revenue in states that follow the cost-of-performance sourcing or the sourcing of tangible goods in states following market-based sourcing methodologies.
Convoluted state tax laws may also increase the risk of double taxation for remote workers. For example, some states have made it clear that a remote worker’s presence in the state could trigger permanent establishment (PE) risk, which requires companies to pay corporate taxes on all revenue generated in the state.
States and localities use the collected sales tax for public welfare activities, including education, health, cleanliness, and security. In addition, sales tax is regressive, meaning poorer citizens pay more than richer citizens. For these reasons, collecting sales tax is a priority for many states. It makes it essential for organizations to know the states where they have nexus to be prepared to collect and report sales taxes for their remote employees. It can be accomplished by conducting a simple research project with the state taxation departments or local tax attorneys.
