State and local tax issues related to remote workforces have existed for many years. However, the pandemic—with the attendant drastic increase in employees working from home or elsewhere—has intensified these issues and brought them to the forefront of taxpayers’ attention. The remote work trend continues even as we emerge from the pandemic, and it is imperative for employers and employees to understand and navigate the intricacies of this new normal to ensure compliance and mitigate risks. In this article, we highlight some important challenges resulting from remote work and provide practical advice for dealing with them.
Background
Millions of US workers have shifted to remote work or hybrid work arrangements and can now work from just about anywhere. Remote work creates opportunities for both employers and employees. Larger employers are rethinking the need to have employees come to a fixed location every day and to maintain expensive office space, and many have shifted to a partially or fully remote workforce. Companies may use the possibility of remote work to recruit employees, with those that do not offer some form of remote option possibly at a competitive disadvantage in the search for the best workers.
From the employee perspective, remote work can offer the opportunity to work from the beach, the mountains, or any other place they like. It also allows employees to spend more time with family and can reduce commuting costs and money spent on meals. Remote work can save time, too, by eliminating lengthy commutes; as the saying goes, time is money. Potential employees will likely view the opportunity to work remotely or on a hybrid schedule as a fringe benefit to consider as part of total compensation.
Though data shows that most employers now require workers to go back to the office at least some of the time, and a recent survey found that nearly seventy percent of employees want to work in an office at least a few days a week, significant tax implications related to remote work remain for both employers and employees.
Withholding
One of the biggest challenges businesses with remote workforces face is determining appropriate state and local tax withholding obligations. Most states impose an income tax on residents and nonresidents alike, with employers being charged with withholding such taxes. An individual’s state of residence or domicile will tax them on all of their income regardless of where the income is earned and typically provides a credit for income taxes paid to other states on the same income. Nonresident employees are traditionally taxed on a source basis, that is, the amount of their wages attributable to their services performed in a state, and employers withhold taxes based on the employee’s primary work location. There are still, however, problems attached to determining where an employee earns personal income associated with work performed at the employee’s home or other location for an employer located in another state.
Several questions must be considered with respect to withholding when an employee works remotely, specifically:
- What is the employee’s state of residency?
- Is there a safe harbor for how long a nonresident employee can work in that state before being subject to taxation?
- Does the employer’s home state have a convenience-of-the-employer rule?
A resident state can tax 100 percent of an individual’s income. A nonresident state, however, can tax only income earned in that state. Different tests determine residency. For example, under New York law, a person’s domicile is their permanent and primary residence that they return to or remain in after being away (for example, on vacation, business assignments, educational leave, and military assignments).1 The test requires a fact-intensive analysis. Under California law, a person’s domicile is determined by the place where they voluntarily establish themselves and family, not merely for a special or limited purpose, but with a present intention of making it their true, fixed, permanent home and principal establishment.2 This is also a fact-intensive test. In determining domicile, courts will look to factors such as ties to a certain location—the value and characteristics of the person’s home in that location, where their family is located, where their business interests are located, the amount of time spent at that location, and whether they keep items of sentimental value there, among other connections.
Under New York law, a person is subject to tax as a resident if their domicile is in New York State or if they maintain a permanent place of abode in New York State for substantially all of the taxable year, and they spend 184 days or more in New York State during the taxable year. Any part of a day is a day for this purpose, and they do not need to be present at the permanent place of abode for the day to count as a day in New York.3 Under California law, a resident is any individual who is present in California for other than a temporary or transitory purpose; or is domiciled in California, but is outside California for a temporary or transitory purpose.4 The default rule with respect to withholding is to withhold based on where an employee performs services, since the rule in most jurisdictions is to source income based on where services are performed. Tracking where employees perform services becomes the primary challenge for employer compliance with state withholding tax requirements. An employer needs employees to provide accurate work locations. Some companies use tracking software to determine where employees perform work, which may help with withholding compliance but raises other issues, including privacy concerns.
Thresholds
States have thresholds for withholding, meaning that an employer must withhold only if an employee works a certain number of days within that state. The easiest scenario is a state that has no personal income tax, such as New Hampshire, and requires no withholding. A number of states (for example, Illinois) have adopted a thirty-day threshold, allowing employees to work within the state for thirty or more days before employer withholding is required.5 Other states like Connecticut permit employees to work in the state between fifteen and twenty-nine days before triggering employer withholding.6 Over twenty states (among them Kentucky) are less taxpayer-friendly and require withholding on the first day an employee works in the state, and New York requires individual employees to file an income tax return on their first day of work in the state.7 Finally, some states (such as Oklahoma) have a wage-based threshold for withholding.8
Model Legislation
Model legislation has been explored that provides for a uniform, fair, and easily administered law that benefits employees who travel for work and their employers. For example, the Council on State Taxation model bill provides for a thirty-day safe harbor from liability for employees who are in the state for less than thirty days during the year and for withholding obligations for employers. Nonresident employees who visit a state and perform employment duties for more than the given days are subject to tax, and withholding is required.9 Unfortunately, it seems highly unlikely that every state will adopt the same thresholds, thus hampering the development of a streamlined approach to withholding.
Convenience-of-the-Employer Rule
A particularly controversial subject in state and local taxation is the so-called “convenience-of-the-employer” rule often adopted by states such as New York that historically have had out-of-state workers commute to work within the state. The rule sources income within the state when employees perform work at home in another state for their in-state employer. New York’s rule sources income to New York when employees perform work at home in another state for their New York employers unless the employer requires the employee to work outside New York. The rule has significant implications for businesses with remote workers, since it may subject employees to additional tax liabilities in states where they physically do not work.
Specifically, New York’s rule says, “any allowance claimed for days worked outside New York State must be based upon the performance of services which of necessity, as distinguished from convenience, obligate the employee to out-of-state duties in the service of his employer.”10 The rule includes as New York working days those days worked outside New York if the employee’s non–New York location was for their convenience rather than for the employer’s necessity.
Though the true motivation behind the rule appears to be to increase (or hold onto) revenue, the rationale has been described as follows: “since a New York State resident would not be entitled to special tax benefits for work done at home, neither should a nonresident who performs services or maintains an office in New York State”; “work performed at an out-of-state home which could just as easily have been performed at the employer’s New York office is work performed for the employee’s convenience and not for the employer’s necessity.”11 Other states have adopted the convenience-of-the-employer rule, including Arkansas, Delaware, Nebraska, and Pennsylvania. Connecticut, Massachusetts, and New Jersey have modified versions of the rule. So the question for an employer becomes: which state’s taxes must be withheld?
Legal Challenges
Several legal challenges have been made to the convenience-of-the-employer rule and similar rules.
New Hampshire v. Massachusetts
Although Massachusetts did not have a convenience-of-the-employer rule prior to the pandemic, it adopted an emergency regulation whereby it would continue collecting income tax from out-of-state residents working from home for Massachusetts companies during the pandemic. New Hampshire does not impose a personal income tax on its residents, and New Hampshire residents, working in New Hampshire, typically do not pay state income tax anywhere. The reason for Massachusetts’ policy was obvious—to maintain revenue it relied upon prior to the pandemic. But was its policy constitutional? New Hampshire filed a motion with the US Supreme Court on behalf of its residents, requesting that the Court find Massachusetts’ temporary emergency regulation an unconstitutional “extraterritorial assertion of taxing power.” One argument Massachusetts raised in its defense was that its regulation requiring withholding based on office location was temporary and had already expired and, therefore, the Court should not accept the case, since the issue New Hampshire raised was moot. Unfortunately, the US Supreme Court did not accept the case, so we have no answer to this question from the Supreme Court, and Massachusetts’ temporary regulation was permitted.12
Zelinsky
A challenge to New York’s convenience-of-the-
employer rule, which predated the pandemic, has lasted decades. Edward Zelinsky, a tax professor at Cardozo School of Law in New York City, taught in the city a few days a week but otherwise worked from his home in Connecticut. He argues that the convenience-of-the-employer rule is unconstitutional and that his days worked in Connecticut should not be sourced to New York. In 2003, when Zelinsky first challenged the rule, the New York Court of Appeals (New York’s highest court) upheld the convenience-of-the-employer rule.13
In 2021, Zelinsky launched another legal challenge to the rule by filing petitions for redetermination for his 2019 and 2020 personal income tax returns. He made similar arguments, asserting that New York could not tax income earned while he worked from home in Connecticut and that doing so violated the due process and commerce clauses of the US Constitution. The case went before the New York State Tax Appeals Tribunal, Administrative Law Judge (ALJ) division, and was argued remotely. Unlike most arguments in that venue, the argument was open to the public via Zoom, since Zelinsky waived tax secrecy protections. Indeed, one of his arguments was that the landscape had changed so dramatically since his 2003 appeal that no one would have at the time imagined an argument watched across the nation. In 2020, in particular, Zelinsky was prohibited from working at Cardozo School of Law in New York for much of the year. He was not working at home for his own convenience; rather, he worked from home because Cardozo forbade him from coming to his New York office due to coronavirus restrictions.
A decision was issued last year finding that, with respect to 2019, the Court of Appeals Decision from two decades ago held, because the parties had stipulated that the facts concerning 2019 were the same as those in the prior challenge. Citing the US Supreme Court’s Wayfair decision, the ALJ found that the convenience-of-the-employer rule also applied to 2020, because Zelinsky had a “virtual presence” in New York that allowed New York to tax him.14 Of course, Wayfair was a sales tax case and did not address the virtual presence concept in the income tax context. Zelinsky has appealed the ALJ’s decision to the New York State Tax Appeals Tribunal, and the case is ongoing there. Likely destined for the New York Court of Appeals and, potentially, the US Supreme Court, this case is one that state and local tax practitioners will follow closely.
Nexus
Having a remote workforce may also impact nexus issues and subject businesses to additional income and sales tax obligations. A company that is not otherwise present within a state may now have filing obligations due to the presence of remote workers there, depending on the frequency and purpose of the work they perform.
Income Tax
Traditionally, nexus for corporate income tax purposes has been established by a company with a physical presence, such as property or employees, within the state. The virtual nature of remote work complicates nexus. Employers may inadvertently create nexus in states where employees work remotely, thereby triggering additional tax obligations. Having even one employee working remotely in a state may be sufficient to create nexus with that state and make the business liable for income tax. In Standard Pressed Steel Co. v. Washington Department of Revenue,15 the US Supreme Court held that just a single employee working from his home was sufficient for Washington to impose its business and occupation tax on the employer.
In 2012, a New Jersey Appellate Court held that an out-of-state company was subject to New Jersey’s corporation business tax because it had one full-time employee, who developed software code that became integral to a product the company offered customers, working remotely from her New Jersey home.16 Even if the out-of-state worker is not technically an employee but is rather categorized as an independent contractor, the independent contractor could potentially create nexus with that state such that a company would be subject to the state’s income tax.
Moreover, a remote workforce could create apportionment considerations for income tax purposes. States may tax multistate businesses only on a fairly apportioned share of their income. Although many states have moved to a single sales factor apportionment formula, a considerable number still include property and payroll factors in their apportionment formulas. The presence of remote workers could create more payroll and potentially more property within a state, increasing the apportionment percentage for that state and subjecting the employer to added tax.
PL 86-272 Considerations
15 U.S.C. Section 381, commonly known as Public Law 86-272 (PL 86-272), provides a safe harbor for certain businesses engaged in interstate commerce. Under PL 86-272, a business is immune from state income taxation if its only activity within that state is soliciting sales of tangible personal property and certain ancillary or de minimis activities. The increase in remote work has raised questions about the applicability of PL 86-272 to businesses with remote employees. For example, having a remote worker could potentially breach an employer’s PL 86-272 protection in a state depending on the nature and amount of the work that employee performs.
Sales and Use Tax
In addition to income tax considerations, businesses with remote workers must also be aware of sales and use tax implications. Sales tax is typically imposed on retail sales of tangible personal property, whereas use tax applies to the use, storage, or consumption of taxable goods and services purchased from out-of-state vendors. The presence of a remote worker in a state may create nexus for sales tax purposes and change how the entity is taxed in the state or locality where the remote worker is located. For example, some states impose different rates on remote sellers and some states offer simplified filing for taxpayers without employees in the state.17 Additional sales tax compliance obligations may result from an employee’s physical presence within a state. Moreover, use tax compliance obligations may arise based on the taxability of purchases used in the taxpayer’s business and purchased in a particular state. Other considerations, depending on the taxpayer’s type of business, may be present, including multiple-point-of-use software, where software is taxed in the location where it is used, and, if an employee’s location changes, then the location of the tax may change, too. A problem may occur when a company cannot accurately track where a remote worker uses property.
The bottom line is that businesses may now be required to collect and remit sales tax in states where their employees are located depending on the nature of the goods or services provided. Similarly, businesses may incur use tax obligations for equipment or supplies that remote employees use in various locations.
Case Law
In the 1995 New York Orvis case, the New York Court of Appeals held that the state could require an out-of-state company to collect sales and use tax based on roughly twelve visits to the state by employees over a three-year period.18 The Intercard case in Kansas went the opposite way.19 The Kansas Supreme Court held that the state could not require an out-of-state company to collect sales and use tax based on eleven visits to the state by employees over a four-year period. The Kansas Supreme Court commented on the New York Orvis case, saying, “The Orvis court ignores . . . that sufficient physical presence is a necessary element of the nexus required for a state to impose a use tax collection duty.” In a post-Wayfair world, the reasoning in cases like Orvis and Intercard is still relevant in instances where an out-of-state business has not met the in-state sales threshold for sales tax nexus but the state nonetheless asserts nexus with the out-of-state business based on the physical presence of the remote worker within the state.
Practical Advice for Employers
We conclude with practical takeaways companies may use when dealing with a remote workforce.
- Strategy. A company should first determine if and how it will embrace remote and flexible work. Consider factors that may impact strategy and policy development (for example, real estate and workplace design, employee experience, employee welfare and fringe benefits, state corporate tax nexus, employment tax implications, and broad-based compensation and regulatory compliance). Remember the nontax implications at play here as well. Review short-term and long-term goals—and decide what the company wants its workplace to look like.
- Infrastructure. To ensure a smooth transition to remote and flexible work arrangements, consider the infrastructure needed to support the business. Establish guardrails and/or business rules concerning where employees can or cannot work and for how long so as not to trigger nexus or other issues. Companies should conduct “nexus reviews” to identify potential exposure areas and develop strategies to minimize tax liabilities. Doing so may involve restructuring business operations or implementing telecommuting policies that limit employee presence in certain jurisdictions.
- Clear communication about company policy for internal processing and employee viewing. The policy should reflect the company’s strategy and the policy’s purpose, providing clear guardrails on which remote/flexible arrangements are supported and which are not. It is crucial for employers to review any current policy and to revise or draft policies and other documents, as needed.
- Approval process for employee remote or flexible work arrangements. Companies should consider developing tools to track employee work locations. This is a controversial subject, since many employees do not want their employers tracking their work location. But then employers would need to rely on accurate self-reporting from employees. To address sales and use tax issues, employers should conduct thorough reviews of their sales and purchasing activities to identify potential tax exposure areas. Doing so may involve implementing sales tax compliance software to automate tax calculations and reporting processes. To ensure they do not run afoul of PL 86-272, employers should thoroughly review their activities within each state and assess whether any unprotected activity exceeds safe harbor thresholds. This may involve implementing policies and procedures to track and document employee activities.
- Staying informed. It is crucial that employers stay up to date on changes in state and local tax laws and legal precedents to inform tax planning and ensure compliance.
- Professional guidance. Consult with experienced tax advisors or attorneys who specialize in state and local taxation to navigate complex issues and ensure compliance with evolving laws and regulations.
Conclusion
It is clear that remote work, at least in some capacity, is here to stay and presents both opportunities and challenges for businesses operating in an increasingly interconnected world. State and local tax implications loom large and require careful consideration and proactive measures to mitigate risks and ensure compliance. By understanding the nuances of withholding and nexus and keeping updated on the latest legislation and court rulings, companies can effectively navigate this new normal.
Eugene J. Gibilaro is a partner in the Tampa office of Blank Rome LLP, and Joshua M. Sivin is of counsel in the New York office.
Endnotes
- See, for example, Black v. Black, 108 A.D.3d 842, 843 (N.Y. App. Div. 3d Dep’t 2013).
- See 18 CCR 17014.
- See NY Tax Section 605.
- See, for example, Estate of El Wardani, 82 Cal. App. 5th 870, 884 (4th App. Dist. 2022).
- See, for example, Publication 130, Who Is Required to Withhold Illinois Income Tax, 08/01/2022.
- See, for example, Conn. Gen. Stat. Section 12-711(b)(2).
- See Ky. Rev. Ann. Section 141.310; Ky. Admin. Regs. 18:010; www.tax.ny.gov/pit/file/nonresidents.htm.
- See Okla. Stat. Section 2385.1.
- Nonresident Withholding and Reporting Threshold Draft Legislation, www.cost.org/globalassets/cost/state-tax-resources-pdf-pages/costs-proactive-legislative-initiatives/draft-model-state-bill-for-minimum-30-day-safe-harbor-for-nonresident-employees-and-their-employers—1.21.22-final.pdf.
- See NYCRR 132.18 [a]
- See Speno v. Gallman, 35 N.Y.2d 256, 259 (N.Y. 1974); Wheeler v. State Tax Comm’n, 72 A.D.2d 878 (N.Y. App. Div. 3d Dep’t 1979).
- Motion for leave to file a bill of complaint DENIED, New Hampshire v. Massachusetts, No. 22O154 (US June 2021).
- See Zelinsky v. Tax Appeals Tribunal, 1 N.Y.3d 85 (2003), cert. denied 541 U.S. 1009 (2004).
- www.dta.ny.gov/pdf/determinations/830517.det.pdf.
- 419 U.S. 560 (1975).
- Telebright Corp. v. New Jersey Department of Taxation, 38 A.3d 604 (N.J. Super. Ct. App. Div. 2012).
- See, for example, Tex. Tax Code Ann. Section 151.0595(a).
- Orvis Co. v. Tax Appeals Tribunal, 86 N.Y. 2d 165 (N.Y. 1995).
- In re Intercard, 270 Kan. at 359 (Kan. 2000).
