MAY 7, 2020
The novel coronavirus (COVID-19) pandemic is changing the way we work. More specifically, it is changing where we work. At first blush, simply working from home might not raise any tax-related red flags. Why should it matter for a business whether its employees work from home temporarily or if they work remotely in a state other than where the employer’s base of operations is located?
In the discussion that follows, we explore three important state and local tax (SALT) effects that could result from teleworking employees. First, what are the employer’s state payroll tax withholding obligations when employees are temporarily working from home in a state different than the normal base of operations, and, what impact could the employer’s withholding have on the teleworking employee’s residence state tax returns? Second, does teleworking due to COVID-19 create nexus in a state? Third, how does teleworking impact the apportionment factors of a multistate business?
Payroll Tax Withholding
When it comes to payroll taxes and teleworking employees, there are implications for the employer and employee. Will an employer’s payroll tax withholding obligations on employees’ wages be affected when those employees are now teleworking at home in another state? For those employees, will their resident state credit withheld payroll taxes of the employer’s state while the employee is teleworking from home? The second issue, unfortunately, is not receiving the attention it deserves from states. As a result, teleworking employees could be subjected to multiple taxation, if the employer’s state allows the employer to follow the status quo, but the employee’s residence state thinks otherwise.
Further, a state such as New York may follow a “convenience of the employer” rule and require withholding of payroll taxes on employee wages while an employee of a New York employer is teleworking outside of New York at their home. New York permits an allowance for days worked outside New York, if “based upon the performance of services which out of necessity, as distinguished from convenience, obligate the employee to out-of-state duties in the services of his employer.” While one could reasonably consider the COVID-19 pandemic to satisfy such an allowance, it appears New York tax authorities may think otherwise.
At least six states have issued guidance on withholding on wages paid to teleworking employees, including Maryland, Massachusetts, Mississippi, New Jersey, Ohio, and Pennsylvania. However, so far, only Massachusetts and New Jersey have provided their residents a corresponding credit for wages subject to withholding by another state due to COVID-19.
In its technical information release, Massachusetts indicates the following:
A resident employee suddenly working in Massachusetts due to a state’s COVID-19 state of emergency who continues to incur an income tax liability in that other state because of that state’s sourcing rule will be eligible for a credit for taxes paid to that other state under G.L. c. 62, § 6(a). In addition, the employer of such employee is not obligated to withhold Massachusetts income tax for the employee to the extent that the employer remains required to withhold income tax with respect to the employee in such other state.
States like Pennsylvania and Mississippi, on the other hand, have instructed employers to continue to withhold on wages paid to employees, as if the employees were not temporarily teleworking in other states. It might seem that those states are doing the companies a favor by allowing them to continue to follow the status quo and not requiring the employer to change its withholding practices. However, the residence state where the employees are now teleworking may see things differently. For example, a Delaware employer with an employee now teleworking from a home in Maryland, the employee’s state of residence, will be required to withhold tax on those wages, because Maryland does not have a reciprocity agreement with Delaware. However, the employer would be excused from withholding if services were being performed by an employee teleworking from a Virginia residence, since Maryland and Virginia are parties to a reciprocity agreement.
State payroll tax withholding as a result of COVID-19 and teleworking raises a host of questions as varied as are the teleworking circumstances of employers and employees. Convenience of employer rules, status quo guidance, reciprocity agreements, and resident state credits are all factors that must be considered.
Nexus
More so than payroll withholding requirements, states have been addressing whether income tax nexus is created by employees temporarily teleworking in a state due to COVID-19 when the employer-business has no other nexus-creating contacts or activities with the state. To date, nine states have issued guidance regarding teleworking employees and nexus – Washington D.C., Indiana, Massachusetts, Minnesota, Mississippi, New Jersey, North Dakota, Ohio, and Pennsylvania.
So far, most of the states listed above have issued high-level guidance in the form of frequently asked questions (FAQs). For example, a Minnesota FAQ stated that “the department will not seek to establish nexus for any business tax solely because an employee is temporarily working from home due to the COVID-19 pandemic.” Similarly, a Pennsylvania FAQ states that “as a result of COVID-19 causing people to work from home as a matter of safety and public health, the department will not seek to impose CNIT nexus solely on the basis of this temporary activity occurring during the duration of this emergency.”
While this is taxpayer-friendly guidance, it does leave some open questions. What exactly does “temporarily” and “due to the COVID-19 pandemic” mean? Does that mean once a state lifts its emergency order, or once the business lifts its own stay-at-home requirement, or even perhaps once the employee decides that her individual health and safety are no longer at risk and ventures back to the office? Outside of factor-based presence thresholds, nexus is traditionally a facts-and-circumstances based analysis.
Indiana’s guidance also indicated that the state will not contend that a teleworking employee performing services or activities not protected by Public Law 86-272 from a home office will cause an out-of-state business to lose the protections of Public Law 86-272 as a result of COVID-19. Further, Indiana recognized that nexus and/or loss of Public Law 86-272 protections are a double-edge sword. For example, nexus in another state can now make Indiana’s sales factor “throwback” rule inapplicable to an Indiana taxpayer that ships sales of tangible personal property from Indiana, or could allow an affiliated group to file an Indiana nexus consolidated return. As a result, Indiana’s guidance also provides that “an employer may not assert that solely having a temporarily relocated employee in Indiana [during the COVID-19 pandemic] creates nexus for the business or exceeds the protections of P.L. 86-272 for the employer.”
Apportionment Factors
Of the three SALT issues discussed in this alert, apportionment is – by far – the least addressed by the states. A possible reason could be that a majority of states have shifted from the traditional three-factor formula to a single-sales factor formula. States without a payroll factor in their apportionment calculation do not need to address whether to include a teleworking employee’s wages in the numerator of a payroll factor.
North Dakota still uses a three-factor formula and has provided payroll factor guidance in an FAQ that provides that compensation of an employee teleworking in North Dakota as a result of COVID-19 will not be assigned to the payroll factor numerator. Likewise, Mississippi’s guidance also states that a taxpayer’s Mississippi apportionment formula will not be impacted by employees temporarily teleworking from homes in the state due to COVID-19.
What about sourcing of services receipts for purposes of the sales factor? This question may not be important for most states, since they have adopted market-based sourcing. For most states, services receipts will continue to be sourced to the location where the benefit of the service is received or where the service is delivered. However, teleworking employees performing services at home and in a state different than the business’s location could present sourcing issues for states that still follow costs-of-performance sourcing, such as Florida or Virginia, or that require pass-through entities to still use costs-performance sourcing, like Michigan and New York. The COVID-19 pandemic and service providers using services performed by teleworking employees could impact where those costs of performance are now incurred.
Insights
The COVID-19 pandemic is presenting a host of impacts to businesses and individuals locally, nationally, and globally. State payroll tax withholding, income tax nexus concerns, and the effect on income apportionment are just the tip of the iceberg. Nonetheless, these state tax issues could continue to impact state taxpayers not only for the current tax year but also future tax years.
With regard to state payroll tax withholding, it is critical for employers and employees to understand their obligations and how teleworking as a result of COVID-19 will impact those obligations. From reciprocity agreements to convenience of the employer rules to current state guidance, state payroll tax withholding compliance has suddenly become substantially more complex with potentially substantial repercussions for the employer and employee.
Similarly, teleworking presents a number of new income tax nexus and apportionment considerations. State taxpayers should understand that COVID-19 will present income tax nexus and apportionment tail risks that may not become manifested until later in the income tax audit cycle. As a result, documentation, record maintenance, and planning should be pursued now so as to proactively prepare for the questions that will be raised not only today, but in the future.