Kathleen K. Wright is the director of the state and local tax program in the School of Taxation at Golden Gate University, San Francisco. In 2015 she was appointed to the California Board of Accountancy, which regulates the licensing and practice of CPAs.
In this installment of States of Mind, Wright discusses tax ramifications of “shelter in place” orders, arguing that the orders expose employers and employees to rules that are difficult to decipher and that vary by state.
“Shelter in place” is defined differently in different states, but generally it all boils down to the same result: Stay at home. The executive orders issued by the governors of most states require that nonessential businesses employ telecommuting (or stay-at-home work procedures) for the foreseeable future.1 The state tax ramifications of these shelter-in-place orders expose both the employer and the employee to a quagmire of tangled rules that are hard to decipher and that vary by state.
As a result of the state shelter-in-place orders, a significant number of workers have found themselves at home, trying to turn the kitchen table into the office conference room, recording studio, or classroom. Not much time to think about the tax consequences of telecommuting. Just like almost every other state tax issue, the bulk of problems arise when you cross state lines. So what does happen when you are now working in a different state from your employer? Read on; this is not an easy question to answer.
Impact on Worker
Situation 1: Joey, an employee of Starlight Productions, is a writer/editor/producer for a popular weekly late-night TV show produced in Burbank, California. Although Joey is a Nevada resident (and maintains a principal residence in Las Vegas) he also has a condominium in Los Angeles where he stays when working at the Burbank studio. After March 20, the show is going to continue to broadcast but will be produced from the home of the various performers, technicians, and so forth. Joey was accustomed to going to the studio every day that he was in Burbank to collaborate with the other writers/directors at their daily meetings to develop the script. Now he is trying to continue to develop the script from his home in Las Vegas, where he has been working since March 19 (when he was told by his production company that the office was closing and all workers were now working from home).
Joey might not fare too badly for state tax purposes. California sources wages based on physical presence. This is the most common sourcing rule employed by the states. Nonresidents are taxable on compensation for services performed only within the state.2 Therefore, if Joey does not come into the state to work, his salary will be sourced to Nevada and he will avoid payment of the California personal income tax, which can be as high as 13.3 percent.
Situation 2: Same facts, except assume that Joey is a consultant for the show and is classified as an independent contractor. The result is not the same as in Situation 1, and Joey finds himself in the middle of a “tempest in a teapot” regarding sourcing the net income of a sole proprietor. Although the issue now appears to be resolved, it all started with Appeal of Larsen,3 in which the taxpayer was a consultant located in Idaho who performed all his services in Idaho.
Larsen received a Form 1099-MISC from a California corporation, but did not report any income to California when he filed his tax returns. Upon audit, the California Franchise Tax Board argued that under 18 Cal. Code Regs. section 17951-4(c), the market-based sourcing rules, applied to the business income earned by a sole proprietorship. The Form 1099-MISC from a corporation with a California address was sufficient information for the FTB to determine that the benefit of the service was received in California. The California Office of Tax Appeals (OTA) did not agree and said the taxpayer had provided a sufficient basis for the OTA to conclude that he was not conducting a business both inside and outside California. The OTA did not view the business as being conducted inside and outside the state. Issuance of a Form 1099-MISC by a California business is not enough to prove an interstate business.
Appeal of Larsen is not a precedential opinion, so it does not have to be followed in later cases. The FTB made clear that it disagreed with the holding in this case4 and indicated that it would continue to pursue this issue.
In Appeal of Bindley5 the taxpayer was a self-employed screenplay writer who received two Forms 1099-MISC for writing screenplays for two different motion picture producers located in California. The taxpayer performed all the work in Arizona and never came to California. This time the OTA determined that the taxpayer carried on a single trade or business both inside and outside the state of Arizona. Therefore, under 18 Cal. Code Regs. section 17951-4 the income of the sole proprietorship must be apportioned by using the market-based sourcing rules set forth in 18 Cal. Code Regs. section 25136-2. Under these regulations, the business income is assigned to California to the extent that the customer of the taxpayer receives the benefit of the service in California. Therefore, whether the taxpayer has income from California sources is determined not by physical presence, but rather where the benefit of the service was received. This decision has been designated as precedential, which means that it will be followed by the FTB in subsequent cases.
In Joey’s case (and applying the result in Appeal of Bindley) the income he receives from the two production companies is sourced to California, whether or not he ever comes to the state. So if Joey ends up writing the screenplays from his home in Las Vegas, the net business income earned from this activity is still sourced to California (just as it would be if he came to California to work on the scripts).
But not all states use solely physical presence to source wages. Five states have added an additional sourcing rule called the “convenience of the employer” test: Connecticut, Delaware, Nebraska, New York, and Pennsylvania.6
Situation 3: Assume that Joey works for Broadway Productions located in New York City. Joey is a writer/editor/producer for a popular weekly late-night TV show produced in the city. Joey is a New Jersey resident, where he maintains a principal residence and commutes into the city. After March 20, the show is going to continue to broadcast, but will be produced from the home of the various performers, technicians, and so forth. Joey was accustomed to going to the studio every day to collaborate with the other writers/directors at their daily meetings to develop the script. Now he is trying to continue to develop the script from his home in New Jersey, where he has been working since March 20 (when he was told by his production company that the office was closing and all workers were now working from home).
New Jersey sources income received for personal services performed in the state to New Jersey. For an individual who works both inside and outside New Jersey, the wages sourced to New Jersey are based on a fraction, the denominator of which is the total days worked and the numerator of which is the days worked in New Jersey. There is no convenience of the employer rule in New Jersey.7 Therefore all Joey’s income while working from home in New Jersey gets sourced to New Jersey.
New York, on the other hand, applies the “convenience of the employer” rule (as well as physical presence). In determining the New York-source income of a nonresident employee, section 132.18(a) of the personal income tax regulations provides:
If a nonresident employee . . . performs services for his employer both within and without New York State, his income derived from New York State sources includes that proportion of his total compensation for services rendered as an employee which the total number of working days employed within New York State bears to the total number of working days employed both within and without New York State. . . . However, 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.8
In the typical scenario, Joey would be taxed twice — once under New Jersey’s physical presence rule and again under New York’s convenience of the employer rule. But there are mitigating factors. Does the governor’s executive order mandating that workers for non-essential businesses stay home (and work from home) meet the definition of necessity? Although there is no guidance yet from the New York tax department, there is plenty of opinion circulating on this issue that supports the “necessity” argument.9
But regardless of the answer that may or may not come from the New York tax department, New Jersey has issued “Telecommuter COVID-19 Employer and Employee FAQ” (last updated March 31, 2020). The last question asks where New Jersey will source the wages for individual income tax purposes if the worker is performing services as a telecommuter or as someone who is temporarily relocated to an out-of-state employer. The response says that during the temporary period of COVID-19, wage income will continue to be sourced as determined by the employer in accordance with the employer’s jurisdiction. In other words, if Broadway Productions is located in New York, and New York sources Joey’s income to New York under the convenience of employer test, then New Jersey will not tax the same income (even though Joey is physically present and temporarily working in the state).
Some states that are in close proximity to New York (and whose residents might experience this double taxation) provide a credit to their residents when they are subject to double tax resulting from the convenience of the employer rule. One such state is Connecticut.
For tax years beginning on or after January 1, 2019, for purposes of determining the compensation sourced to Connecticut, residents of states with a convenience of the employer test will be subject to similar rules for work performed for a Connecticut employer. In accordance with that test, wages earned by a nonresident are allocated to the employer’s location unless the nonresident works from an out-of-state location because of the necessity of the employer rather than the convenience of the employee. Connecticut resident employees working from a remote location who are subject to tax on income earned in a jurisdiction that applies the convenience of the employer test will be eligible to claim a credit on their Connecticut income tax returns for taxes paid to that jurisdiction.10
Therefore, if Joey lived in Connecticut, was working at home for Broadway Productions, and was required to pay New York state income tax, then he should get a credit on his Connecticut income tax return for the New York tax paid. There still may be some amount of double tax if the rates in Connecticut and New York are not the same, but it is better than nothing.
Issues for Employer
Nexus. A business is generally considered to be doing business and subject to the state’s income tax if the business has employees working in the state. Even in states that have enacted statutory thresholds that define “doing business,” not much leeway is granted for payroll sourced to the state, which indicates physical presence, a traditional indicator of nexus for commerce clause purposes. Under the Multistate Tax Commission model rule, a taxpayer establishes nexus with a state for business activity tax purposes if the taxpayer exceeds any of the following apportionment factor numerator thresholds in that state during a tax period:
$50,000 of property;
$50,000 of payroll;
$500,000 of sales; or
25 percent of total property, total payroll, or total sales.11
Situation 4: Assume that Joey works for Broadway Productions located in New York City. Joey is a writer/editor/producer for a popular weekly late-night TV show produced in the city. Joey is a New Jersey resident, where he maintains a principal residence and commutes into the city. After March 20, the show is going to continue to broadcast, but will be produced from the home of the various performers, technicians, and so forth. Joey was accustomed to going to the studio every day to collaborate with the other writers/directors at their daily meetings to develop the script. Now he is trying to continue to develop the script from his home in New Jersey, where he has been working since March 20 (when he was told by his production company that the office was closing and all workers were now working from home).
The traditional view is illustrated in Telebright Corp. v. Director, N.J. Superior Court, Appellate Division.12 A foreign corporation that regularly and consistently permitted one of its employees to telecommute full time from her New Jersey residence was doing business in New Jersey, subject to the corporate income tax in New Jersey, and was required to file corporate income tax returns in the state. In this case, the employee developed and wrote software code from a laptop computer in New Jersey and then uploaded it to the company’s computer server in another state. New Jersey was imposing the tax because an employee performed work for the company on a full-time basis in New Jersey and was entitled to all of the protections offered by the state to New Jersey residents.
But on March 30, 2020, the New Jersey Division of Taxation announced that as a result of COVID-19 causing people to work from home as a matter of public health, safety, and welfare, the division will temporarily waive the impact of the legal threshold within N.J.S.A. 54:10A-2 and N.J.A.C. 18:7-1.9(a), which treats the presence of employees working from their homes in New Jersey as sufficient nexus for out-of-state corporations. In the event that employees are working from home solely as a result of closures due to the coronavirus outbreak or the employer’s social distancing policy, no threshold will be considered to have been met.
At least three other states (Indiana, Mississippi, and Pennsylvania) and the District of Columbia have also provided relief for businesses with telecommuters. On April 6, 2020, the Indiana Department of Revenue announced that it will not seek to impose the corporate income tax against an out-of-state taxpayer based on temporary remote work by an employee. On April 3, 2020, the Pennsylvania Department of Revenue indicated that for corporate income tax purposes, telecommuters working from home will not create nexus for the out-of-state employer. On March 26, 2020, the Mississippi Department of Revenue issued a notice saying that withholding requirements remain unchanged based on an employee's temporary telework location, and the department will not use any changes in the employees' temporary work location to impose nexus or alter any income apportionment while those temporary telework requirements are in place. On March 11, 2020, the District's mayor declared a public emergency caused by COVID-19. What followed was a statement from the District's Office of Tax and Revenue that it will not seek to impose the corporation franchise tax or unincorporated business franchise tax nexus solely on the basis of employees or property used to allow employees to work from home temporarily located in the District.13
This is good news for Broadway Productions, which should not be considered as doing business in New Jersey solely because Joey is working from home.
Wage Withholding: The employer nightmare of properly withholding income tax from wages of an employee who works in another state (or travels to different states) has been a topic of discussion for years, ultimately reaching Congress in the form of several bills that were introduced in both houses but never passed. The dilemma relates to the threshold requirements before wage withholding is required. The first complexity is that these rules do not follow the same rules that govern taxability of the nonresident’s wage earned in a state. The issue goes downhill from there, as each state has slightly different thresholds before withholding is required.
Situation 5: Assume that Joey works for Broadway Productions located in New York City. Joey is a writer/editor/producer for a popular weekly late-night TV show produced in New York City. Joey is a resident of New Jersey, where he maintains a principal residence and commutes into the city. After March 20, the show is going to continue to broadcast, but will be produced from the home of the various performers, technicians, and so forth. Joey was accustomed to going to the studio every day to collaborate with the other writers/directors at their daily meetings to develop the script. Now he is trying to continue to develop the script from his home in New Jersey, where he has been working since March 20 (when he was told by his production company that the office was closing and all workers were now working from home).
New York employers must withhold tax for both resident and nonresident employees who work in New York.14 However, for the year 2020, Joey will work partly in New York and partly in New Jersey. In this case, the employer is responsible for withholding on wages paid to nonresidents who work partly within and partly outside the state, unless Form IT-2104.1 is filed, or unless the employer keeps accurate, adequate records showing in-state pay.15 Broadway Productions should have records showing that Joey worked in New York until March 20, 2020. Up until March 20, Joey (a resident of New Jersey) was employed wholly outside New Jersey and would have been subject to withholding in New York, where he was employed. Broadway Productions would have been required to withhold New Jersey tax only if the New Jersey tax was in excess of the amount withheld from the employee’s wages for New York. Unlikely.16
But now Joey is working in New Jersey. Under the general rule, every corporate entity that maintains an office or transacts business within New Jersey and pays wages subject to the New Jersey gross income tax to a resident or nonresident employee must deduct and withhold tax. The amount of the tax that must be withheld is the tax reasonably estimated to be due from the employee based on the New Jersey wage paid during that calendar year.17
However, on March 31, 2020, the New Jersey Division of Taxation issued “Telecommuter COVID-19 Employer and Employee FAQ.” In response to the question on employer withholding and employees working from home in New Jersey, the division responds that during the temporary period of the COVID-19 pandemic, wage income will continue to be sourced as determined by the employer in accordance with the employer’s jurisdiction. Therefore, it appears that for the moment, Broadway Productions can continue to withhold the New York income tax.
Conclusion
The purpose of this article was to point out some of the issues that can arise for employers/employees when you cross state lines. Most states have not responded to the tax issues regarding workers who now telecommute. In my home state of California, there has not been any relaxation of the doing business rules or the wage withholding requirements. “Doing business” means actively engaging in any transaction for financial or pecuniary gain or profit. Also, California applies a factor-based nexus standard, under which a corporation is considered to be doing business in the state if it has over $50,000 (adjusted for inflation) of payroll in the state.18
California also requires withholding on payments to nonresidents when the payment exceeds $1,500.19 Both of these thresholds are likely to be exceeded by employees who are working at home for the foreseeable future. This means that the employer may very well be doing business in the state and will have to register with the secretary of state and commence filing income tax returns. The employer also will be required to start withholding state income tax from the employee’s wage.
So a big “shout out” to New Jersey for thinking ahead and being in front of the curve on secondary issues resulting from COVID-19, and here’s hoping that the other states wake up to the many dilemmas facing employees and employers as a result of the pandemic.
FOOTNOTES
1 See Executive Order N-33-20 issued by California Gov. Gavin Newsom (D) on March 19, 2020, and Executive Order 202.6 issued by New York Gov. Andrew Cuomo (D) on March 20, 2020, as examples.
2 Cal. Rev. & Tax. Code section 17041(b)(1); Cal. Rev. & Tax. Code section 17951; and Cal. Code Regs. tit. 18, section 17951-1.
3 2018-OTA-073, July 25, 2018.
4 California Franchise Tax Board, “Office of Tax Appeals Decision — Appeal of Larsen” (Feb. 2019).
5 2019-OTA-179P, May 31, 2019.
6 Conn. Gen. Stat. section 12-711(b)(2)(C); Del. Code Ann. tit. 30, section 1124(b); Neb. Rev. Stat. section 77-2733(8); New York Technical Service Bureau Memorandum No. TSB-M-06(5) (May 15, 2006); and Pennsylvania Personal Income Tax Ruling No. PIT-03-031 (Sept. 16, 2003).
7 N.J. Rev. Stat. section 54A:5-8(a)(2); Instructions to Form NJ-1040NR; and email from Regulatory Services (Mar. 13, 2020).
8 See also New York Technical Service No. TSB-M-06(5)I (May 15, 2006).
9 Joseph N. Endres and Timothy P. Noonan, “COVID-19 Impact on New York Residency, Day Counts, and Allocation,” Tax Notes State, Apr. 13, 2020, p. 133. Edward A. Zelinsky, “Coronavirus, Telecommuting, and the ‘Employer Convenience’ Rule,” Tax Notes State, Mar. 30, 2020, p. 1101.
10 Conn. Gen. Stat. section 12-711(b)(2)(C); Connecticut 2018 legislative summary (June 4, 2018); Connecticut Informational Publication No. 2019(1) (Jan 31, 2019); and Connecticut Special Notice No. 2019(12) (Mar. 4, 2020).
11 On October 17, 2002, the Multistate Tax Commission adopted a model rule, “Factor Presence Nexus Standard for Business Activity Taxes.”
12 Dkt. No. A-5096-09T2, Mar 2, 2012, 424 N.J. Super. 384, 38 A3d 604 (2012).
13 Indiana: DOR Coronavirus Information, Indiana Department of Revenue (Apr. 6, 2020). Mississippi: Department of Revenue Response to Requests for Relief (Mar. 26, 2020). Pennsylvania: Consumer Support Answers — Corporate Nexus, Pennsylvania Department of Revenue (Apr. 3, 2020). District of Columbia: Mayor’s Order 2020-045 and 2020-46 (Mar. 11, 2020).
14 N.Y. Tax Law section 671(a); and N.Y. Comp. Codes R. & Regs. tit. 20, section 171.6.
15 N.Y. Comp. Codes R. & Regs. tit. 20, section 171.6(b)(5).
16 Instructions, Form NJ-WT, “New Jersey Gross Income Withholding Tax.”
17 N.J. Rev. Stat. section 54A:7-1(a); and N.J. Admin. Code section 18:35-7.2(a).
18 Cal. Rev. & Tax. Code section 23101.
19 Cal. Rev. & Tax. Code section 18662; and California FTB, Pub. 1017.
END FOOTNOTES