Google the phrase “remote work,” and you’ll get about two million results for news articles like “Remote work is great,” “Remote work doesn’t work,” or “How to make remote work work.” Only a slim fraction of this coverage mentions the state tax consequences of employees working from somewhere other than the office.
COVID-19 forced many businesses into remote work, and made them rethink their openness to the idea. Moving forward, businesses that continue to allow remote work will have to deal more fully with the state tax consequences of a geographically dispersed workforce. Below are four key areas of state tax impact and current guidance for businesses and employees in the evolving legal and regulatory environment around this new style of work.
Withholding Tax for Remote Employees
During the pandemic, many state and local jurisdictions temporarily directed employers to continue withholding income tax from employees based on their normal work location, even if they were working from home in another state or locality. While these measures were understandably intended to ease compliance burdens on employers and maintain steady tax revenue to jurisdictions, questions remain as to their legality and ongoing implementation as the pandemic lasted longer than expected. For example:
- States have different definitions of when the temporary withholding measures end – some have set a specific date, while others say it is dependent on when COVID-19 restrictions disappear. For those dependent on restriction rollback, it is often unclear whether the referred-to restrictions are those in the employer’s state or the remote worker’s state.
- These measures were intended to cover temporary relocation by employees who ultimately will come back to their normal work location. Even though two employees may have both relocated, the withholding requirements might be different depending on what happens in the future regarding their work locations.
Here are two areas requiring further guidance or clarification:
- For employees hired remotely during the pandemic, it appears, but is not clear, that taxes will generally still need to be withheld in their work location, not the location of the employer, since they are not working remotely because of the pandemic. States offered this interim relief to cover temporary relocation of employees.
- Pending an answer from the Pennsylvania Department of Revenue, professional opinions are divided as to whether Pennsylvania’s “convenience of the employer” doctrine causes fully remote employees working from their home in another state for a Pennsylvania-based company to be subject to Pennsylvania withholding.
Unemployment Tax for Remote Employees
The U.S. Department of Labor governs sourcing rules for unemployment tax, providing more consistency on this issue across the country. Even as employees moved to different states to work remotely during COVID-19, all of their wages continued to be reported to their original state of employment, unless the situation extends beyond a temporary basis. For this purpose, “temporary” is considered less than 12 months, meaning that by this point in the pandemic, it is possible that some remote workers have been working in a state other than their normal location for more than 12 months and changes in sourcing of wages for unemployment may be necessary. Given the low balances in many states’ unemployment insurance funds, we anticipate states could become aggressive about this issue to ensure they get the unemployment tax they feel they deserve.
Any employee who permanently changed their work location, even before the 12-month mark, most likely needs to be sourced to their new state of work. Employee movement between states must be reported carefully for unemployment tax purposes to avoid double taxation of wages.
Income Tax and Sales Tax Nexus
Just like employee withholding, many jurisdictions announced relief during the pandemic from the normal rule that having an in-state employee creates nexus for paying income tax and collecting sales tax from customers. If employees stay remote, businesses need to be prepared for additional compliance obligations in these areas, as even the temporary presence of one employee can create filing requirements.
Income Tax Apportionment
Even in states where a business already files income tax returns, the movement of employees (or the hiring of new ones) can affect how much income tax is paid to those states. About 15 states still use some form of three-factor apportionment, meaning that having employees in those states will increase apportionment and the amount of income taxed there. For service providers, the location of employees performing services can affect sales apportionment, as there are still about 15 states using cost-of-performance sourcing that looks at where the work is done instead of where customers are located.
These state and local tax consequences will become more relevant as the pandemic ends and states’ temporary relief measures expire, but businesses should not wait until it happens to them. Contact your RKL advisor today to determine the impact of an employee moving or out-of-state hiring decisions. This proactive analysis could show significant dollars at stake and inform business decision-making.