How working from home during — and after — the pandemic may impact income tax nexus

Update 5.13.2020: New York Governor Cuomo says residents of other states temporarily working in New York will be liable for New York income tax: "We're not in a position to provide any subsidies right now because we have a $13 billion deficit." 

A bill introduced in Congress in January would interfere with the governor's plans. The Mobile Workforce State Income Tax Simplification Act of 2020 (H.R. 5674) would prohibit wages earned by certain employees working in more than one state from being subject to income tax in any state other than (1) their state of residence, and (2) states where the employee is present and performing employment duties for more than 30 days during the calendar year. 

So many of us are eager to put the new coronavirus (COVID-19) pandemic behind us — to return to the workplace, get our kids back in school, hug our friends and families. Yet even as some states are easing restrictions, others are still encouraging us to stay home. It could be time to invest in a standing desk for the home office.

Certain industries lend themselves to remote working. Although there’s no way for the local dentist to fill a cavity via Zoom, many jobs can be completed with a laptop and internet service. Thus, many of us may end up working from home for months to come.

This newly remote workforce could have unexpected corporate income tax implications for employers, especially if employees live and work in different states or cities. And that’s not uncommon.

Kansas City straddles Kansas and Missouri. Washington, D.C., is nestled between Maryland and Virginia. Philadelphia sits between Delaware and New Jersey. You can practically skip a rock from Hoboken, New Jersey, to Greenwich Village, New York. Before the COVID-19 pandemic confined daily commutes to within four walls, commuters regularly traveled between these and other places at the start and end of each workday.

What impact do remote employees have on their employers’ nexus?

Nexus is a connection between a business and a taxing authority that establishes a tax obligation for the business. Simply put, a state can impose a tax obligation on a business that has nexus but not on a business that doesn’t have nexus.

Sales tax nexus was historically based on physical presence, having a physical connection to a state. However, that changed when the Supreme Court of the United States overruled the physical presence rule in South Dakota v. Wayfair, Inc. (June 21, 2018). The Wayfair decision allows states to base a sales tax collection obligation solely on a remote seller’s sales in the state, or economic nexus. In other words, nexus can now be created without a physical presence.

Even before Wayfair, several states (e.g., Alabama, California, and New York) held out-of-state businesses that met a certain threshold of sales in the state liable for income tax. Wayfair may embolden others to apply economic nexus more broadly as well. Indeed, while 43 states now enforce economic nexus for sales tax, at least six apply it to other taxes:

• California to franchise tax
• Hawaii to income tax
• Ohio to commercial activity tax (CAT)
• Texas to franchise tax
• Washington to business and occupation (B&O) tax
• West Virginia to income tax

Of course, the remote workforce established by the COVID-19 pandemic threatens to unleash more instances of old-school nexus, connection based on a physical presence in the state. So, do employees (and their company-owned laptops) establish nexus for their out-of-state employers?

They could.

While the situation with COVID-19 is unprecedented, states aren’t entirely without precedent. Businesses frequently send employees to other states to lend a hand when natural disasters strike: Utility workers travel from neighboring states to restore power knocked out by high winds in Washington, floods in Texas, and tornadoes in Tennessee.

It would be bad form for a state to slap taxes on a business that’s come to its aid, especially if that’s the only reason the business is working in the state. Not surprisingly, most states ensure that won’t happen.

According to Scott Peterson, vice president of U.S. government relations and tax policy at Avalara, approximately 37 states have laws exempting utility companies from taxation “when they bring in an army of out-of-state repair people to respond to a natural disaster.” These laws typically contain three essential features; they:

• Allow out-of-state businesses and employees to perform services in the state without registering, filing, and/or remitting state or local taxes
• Amend state laws regarding thresholds for establishing presence, residence, or doing business in the state for out-of-state employees and businesses temporarily working in the state during an emergency
• Exempt out-of-state employees from filing and paying income taxes or being subject to withholding or other taxes

These policies can serve as a model during the current COVID-19 pandemic, which is a natural disaster of another sort.

A growing number of states have already stated they won’t enforce certain nexus provisions related to remote employees — at least not for employees who are temporarily working from home to help slow the spread of the virus. These include:

• Indiana
• Maryland
• Massachusetts
• Minnesota
• Mississippi
• New Jersey
• North Dakota
• Pennsylvania
• Washington, D.C.

Some states provide more guidance than others.

The Indiana Department of Revenue states that the temporary protections from establishing Indiana nexus apply while there’s an official work-from-home order issued by an applicable federal, state, or local government unit; or pursuant to the order of a physician in relation to the COVID-19 outbreak or due to an actual diagnosis of COVID-19, plus 14 days to allow for return to normal work locations. Because Indiana’s rules are fact based and employee specific, employers should carefully monitor state and local announcements and employee-specific situations.

The Comptroller of Maryland offers a wealth of information, summarized here: “Generally, Maryland imposes income tax … on employers, for employees domiciled in Maryland, statutory residents of Maryland, and non-residents receiving Maryland-sourced income. … Residents of Virginia, Washington D.C., West Virginia, and Pennsylvania who earn wages, salaries, tips, and commission income for services performed in Maryland are exempt from Maryland state income tax, and therefore, withholding, because Maryland has a reciprocal agreement with these states. Unlike the aforementioned states, Delaware has not entered into a reciprocal agreement with the state of Maryland. Compensation paid to a Maryland nonresident who is teleworking in Maryland is Maryland-sourced income, and therefore, subject to withholding.”

The Pennsylvania Department of Revenue isn’t changing income tax sourcing for employees temporarily working from home in other states, even in states that don’t have a reciprocity agreement.

As evidenced above, states aren’t unsympathetic to situations brought on by the pandemic. Most have indicated a willingness to work with companies and individuals having a hard time fulfilling their tax obligations because of declining business or lost work caused by COVID-19. Yet that goodwill is unlikely to last forever. Indeed, all of the states listed above have indicated relief from income tax nexus for temporary teleworkers will terminate once the COVID-19 crisis passes. Whenever that is.

The hard truth is that states rely on tax revenue to keep the lights on and pay for essential services. The longer COVID-19 lasts, and the greater its impact, the more money will be needed for assistance programs. Even states taking a lenient stance toward temporary remote employees could reevaluate those policies, especially if a “temporary” situation stretches to months. And it might.

Although some states are relaxing stay-at-home orders and allowing so-called nonessential businesses to reopen, many businesses may opt to keep at least a portion of their employees remote. According to a recent report by Gartner, 74% of CFOs and business leaders surveyed plan to “move at least 5% of their previously on-site workforce to permanently remote positions post-COVID 19.” Some businesses plan to keep as many as half of their employees remote moving forward.

Such new working conditions could put businesses under the microscope of states in dire need of more revenue. Right now, many states consider the current situation to be temporary: Employees are working from home or under quarantine only because of the pandemic. Will they continue to be so lenient if employers decide it’s best to keep employees working from home permanently?

They may not. New York, a state whose budget has been gutted by COVID-19, is already well known for going after residents of other states for income earned in New York: “You never have to set foot in New York to owe its taxes. Try to exclude even a portion of that income and expect an audit as a rule of thumb.” (Hat tip to Bloomberg Government).

There are still many unknowns right now. First and foremost, we don’t know how long the current COVID-19 pandemic will last, if it will return after it abates, or if another new coronavirus will take its place. But eventually normalcy will return, even if it’s a new normal. When that happens, we should be prepared for state tax authorities to start looking for ways to replenish their tax base.

In the meantime, enjoy getting to know your colleagues’ kids and cats — and seeing the homes of the Saturday Night Live cast.