COVID-19, Working from Home & US State Tax Issues
Alex Margolin| Nov 04, 2020
The Covid-19 pandemic has forced many businesses to shift quickly from the office to a work-from-home arrangement. Some of these companies were already on the road to expanding remote work. Others were forced to adopt new work-from-home policies before they could fully consider all of the ramifications.
Much has been written about how working from home influences employee productivity and motivation. Much less attention is paid to more prosaic considerations such as how work from home could impact taxes on the state and local levels.
Take the case of the employee who lives in one state and works for a company located in another state. For example, an employee lives in New Jersey but commutes to work at company headquarters in New York. In pre-Covid, non-emergency conditions, some states (including New Jersey) consider an employee working from home full time in the state as enough to constitute a tax nexus – a sufficiently significant connection forcing the company to pay state taxes to that state for work performed in the state.
When the employee worked at the company’s building in New York, state taxes would be paid to New York since taxes go to the state where the work is performed. But if that employee is now working from home in New Jersey, the work is being performed in a different state. (Laws vary from state to state, so always check the specific laws and procedures for every state where you have employees.)
Does the presence of an employee performing work in a different state require the company to report and pay taxes for the employee in both states due to the tax nexus? What if the business was located in a state with no income tax, such as New Hampshire, but the employee lives in Vermont, which does have an income tax? Is the employee now subject to that state’s income tax because he or she is unable to work in the office?
In addition, labor laws differ from state to state on matters such as minimum wage, overtime pay, insurance payments, and other matters. A company may need to comply with the labor laws of the employee’s state concerning the employee.
Some states, including (but not limited to) Indiana, Georgia, Massachusetts, Minnesota, Mississippi, New Jersey, North Dakota, and Pennsylvania have announced that they would not assert an income tax nexus solely based on employees forced to work from home in response to the Covid emergency. But it remains to be seen how even those states will respond once the emergency is lifted and companies want to continue with the new work arrangement.
Reciprocal Agreements on Taxes Between States
In most cases, people who live in one state but work in another have to file two sets of tax returns – a resident tax return in the state where they live and a non-resident return in the state where they work.
This is significant to the employer as well. If the state where the employee is physically performing the work is different from the state where the business is officially registered, it usually creates a tax nexus, requiring the employer to register with that state as well and pay employer taxes to the state where the work is being performed.
The exception to these rules – for both the employer and the employee – is if there is a reciprocal agreement between the states.
Currently, 17 states and the District of Columbia have reciprocal agreements with one or more other states, mostly with states along their borders. An employee who lives in one of the states but works in the other would only be required to file one tax return, the resident state tax form. In other words, if there is a reciprocal agreement in place between states, employees only report to and pay state taxes to the resident state, and employers withhold taxes for the resident state, whichever that may be for the employee.
As an illustration, New Jersey has a reciprocal tax agreement with Pennsylvania. The Pennsylvania Department of Revenue describes the relationship with New Jersey in these terms:
Pennsylvania residents who work in New Jersey will continue to be subject to the Pennsylvania personal income tax and have Pennsylvania personal income tax withheld from compensation received in New Jersey.
Pennsylvania employers will continue to withhold New Jersey personal income tax on behalf of their New Jersey resident employees, and remit that tax to the State of New Jersey.
Sounds simple and straightforward, but of course, there is one more important detail. The employee has to provide a non-resident form to the employer to be free from having to file a non-resident tax form. The forms differ from state to state. Residency is determined by the address provided on the employee’s W-4 form.
When There are No Reciprocal Agreements
A reciprocal agreement requires that the employee live in one of the states in the agreement and work in another state that is part of the agreement. So while New Jersey has an agreement in place with Pennsylvania, it has no such agreement with New York. Thus, an employee who lives in New Jersey but works in New York would file both a resident and non-resident tax return.
In most cases, the employer would also have to register with the employee’s resident state and pay employer taxes there. Also, the business will probably have to register with the local tax authorities as well, since the municipal taxes of the local address will apply. Different states and municipalities have different standards for creating a tax nexus, therefore it is important to consult with a tax expert to learn how different states related to out of state employees.
In most cases, the employee will receive tax credits for the income taxes paid to the resident state to avoid being taxed twice on the same earnings.
Withholding the correct state and local taxes and filing the right paperwork could be complicated. Each state has its own standards and procedures, and it could be different for every out of state employee working remotely for the company.
Steps Moving Forward
The Covid pandemic has greatly accelerated the rate at which companies are moving operations fully or partially to remote arrangements. Some of these companies will continue to integrate some level of remote work in the future. To do so properly, they should consider the following:
- Know where each of the employees lives and where they will be performing the work. This is vital information to ensure compliance in all tax payments and tax reporting.
- Be familiar with the local tax and labor laws of the states where the employees will be performing the work. It is best to work with a tax expert, who can advise on each state’s standards for a tax nexus and related issues. Experts can also advise on the best way to protect employees from double taxes and ensure that their paperwork includes all the necessary forms to receive tax credits.
- Register with the state and local tax authorities in each state where employees are working. Don’t get caught off guard when it comes time to calculate payroll.
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All information, links, and comments provided in this article are for informational and self-help purposes only and are not intended to be a substitute for professional legal advice.