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Does Work From Anywhere Mean Paying State Taxes Everywhere?

Posted on Jan. 17, 2022
Steven N.J. Wlodychak
Steven N.J. Wlodychak

Steven N.J. Wlodychak is the former indirect (state and local) tax policy leader for EY’s Americas Tax Policy and a retired principal in EY’s National Tax Department in Washington, D.C.

In this installment of The Hissing Goose, Wlodychak identifies some state and local tax consequences of the COVID-19 pandemic that businesses and workers should consider.

One surprising outcome of the ongoing pandemic is that many workers and their employers have proved quite adeptly that nearly anyone can work and collaborate with anyone else on anything from anywhere. Improvising with an assortment of high-speed internet connections and enhanced video conferencing software, workers (who were prohibited by governmental restrictions from reentering their offices for months) and their employers rapidly figured out novel workarounds that allowed workers in so many different fields to continue to work efficiently and, in some cases, even more effectively from their homes — or, for that matter, from wherever they preferred. Even though the restrictions that mandated “work from home” are relaxing as the pandemic recedes, many workers who have the option are likely to choose to rarely go back to the office (and employers, for the most part, will be perfectly fine with that decision). Instead, out of choice or necessity, the work-from-home (or better yet, the “work from anywhere” (WFA)) solution is here to stay.

One consequence of this freedom to work from anywhere will be the U.S. state and local tax implications of those personal decisions, not only for the workers themselves but also for their employers. Those implications will not simply be confined to the obvious concerns such as to which state or local taxing jurisdictions personal income tax of the workers should be reported and paid, or in which state their activities would create nexus that would allow the state or local jurisdiction to impose their taxes. Instead, myriad SALT compliance concerns will arise that present both hazards and opportunities — businesses will have to come up with new internal controls and procedures to routinely report where their workers are in fact performing services, where they and their employees will have to pay state and local taxes, and how those taxes can be accurately determined.

The purpose of this article is not to offer any solutions; that’s going to take some time, and solutions will depend upon each business’s (and its employees’) specific facts. Instead, its purpose is to identify a few of those SALT consequences that businesses and workers must consider, some certainly more obvious and immediate than others. I also profess I don’t have all the answers, or even the ability to identify all the issues, but I hope this short list of problems will provoke readers to think of still other SALT issues that will need to be addressed as the new WFA environment becomes the norm rather than the exception.1

Some of these problems can and will be solved through simple changes in reporting or management. Others may be more complex and could benefit from mobile software and data solutions that haven’t even been devised yet. Still others may be so intractable and conflicting that they demand enactment of new legislation or regulatory solutions, which will require greater cooperation and coordination among every state and local government to fairly address and avoid burdensome double taxation. Out of all of this, though, only one thing is certain: We’re never going back to the way things were done before the pandemic, and businesses, their employees, SALT practitioners, and state and local governments are going to have to start searching for these problems and offering practicable and fair solutions right now.

General State Tax Considerations

Nexus — In Which States Do We Have to Comply?

The primary and most obvious consideration of the new WFA paradigm is nexus, because that issue will affect every SALT consideration without exception. Nexus, as defined by over 200 years of U.S. Supreme Court precedent under the U.S. Constitution, simply refers to the level of connection a taxpayer or a transaction must have to a jurisdiction for that jurisdiction to impose its taxes. In many cases, states impose stricter limitations under their own statutory “doing business” standards that can vary among many different types of taxes in many different situations.2 Nexus and these state doing-business standards even have an international analog in the concept of permanent establishment as universally defined by global tax treaties.3

For as long as states have imposed taxes, almost universally the taxpayer or the transaction had to have some presence, historically physically within, but also more recently purposefully directed into, the jurisdiction. Few would care to challenge whether the physical presence of an employee working in a location, even remotely, creates the requisite physical contacts that allow a state to impose its tax authority not only on that individual but also on his or her employer. Moreover, I think most would agree that that authority should extend not only to the personal income taxes that could be imposed on that individual regardless of residence but also to any other tax that the state or local taxing jurisdiction chooses to impose on activities connected to that jurisdiction.

State and local jurisdictions impose a wide variety of taxes, including business income, franchise, gross receipts, sales and use, and property taxes, all of which fundamentally rely upon the requisite nexus of the taxpayer to the jurisdiction. Unless the state creates a statutory or regulatory de minimis or other exception (for example, a bright-line payroll threshold denoted by the number of days an employee spends working in the state, the amount of aggregate payroll paid to a taxpayer’s workers in the state, or an exception limiting imposition of tax if the taxpayer’s in-state activities are restricted to a specific kind of activity, such as responding to local emergencies or attending trade shows) or the federal government enacts a broad form of preemption applicable to all the states (for example, P.L. 86-272 protected sales solicitation activity,4 limitations on the imposition of nonresident taxes on workers engaged in interstate transportation activities,5 and on some retirement income6), the physical presence of an employee in a state or local taxing jurisdiction universally is recognized as a precondition that allows the jurisdiction to impose its tax payment and collection responsibilities on the taxpayer.

During the pandemic and when they could, a number of states issued emergency orders relaxing these nexus rules in response to the WFA situation (for example, New Jersey and California). Typically, these states’ emergency rules excepted an out-of-state employer from having to file and pay the state’s taxes if the only activity was the presence of employees temporarily working in the state because of the pandemic restrictions imposed by that state or other states. As these pandemic orders recede and the old nexus rules kick back in, if employers choose to allow the WFA arrangements, they are going to have to be vigilant in identifying when, where, and for how long their employees are working in a particular jurisdiction. Moreover, they are also going to have to be able to quantify the time spent in the jurisdiction and not only assign the compensation paid to the employees while working there but also determine the costs related to that work to compute SALT-specific information, such as apportionment and allocation (such as the property used by employees in the state and the revenues and income generated from those employees’ activities), in order to make sales factor determinations for their own state income tax purposes.

Income Tax Apportionment and Allocation

Where a worker performs services can affect the determination of the state to which the revenues from those activities are assigned for purposes of determining the employer’s apportionment factors. Those determinations will directly affect how much business tax the employer will have to pay to the state. Although probably more important when a state’s apportionment factor included a payroll factor, that issue will still be relevant when receipts are sourced for sales factor apportionment purposes based upon where the business activities were performed or for gross receipts tax purposes (for example, Ohio commercial activity tax, or city business taxes such as the Los Angeles business tax based on gross receipts). Notably, those in service industries will have to readily identify where the revenues generated by an employee’s activities should be sourced. When the employee is rendering personal services, the rules among the states often conflict regarding whether the associated revenues should be sourced to the place where the employee performed those services or where the beneficiary of the services is located. Employers will have to determine which rules apply and accordingly collect the data based on their employees’ activities in the state to capably render their business tax returns. When the workers directly benefit from the services at a WFA location, sellers will have to impose procedures to properly source those receipts to the correct jurisdiction.

Which State Gets the Sales Tax, and What’s Taxable?

This raises an even more interesting sales tax issue, particularly if the sale involves the use of software or other taxable services that aren’t easy to geographically locate. If an employer purchases software and downloads it in one state, should the sales tax apply in the “primary” work location of the employer, or does the WFA location of the employee now jump to the front of the line? Which state’s rules apply?

A number of states identified this problem even before the WFA model took off and began to offer a “multiple point of use” exemption certificate.7 In those states, a business that purchases software that might be used by its employees located in any number of states could claim exemption from sales tax. In doing so, the buyer would assume the burden of the proper reporting of the use tax based on the work location of its employees who used the software. Obviously, the information about a WFA location could be useful and invaluable to more properly allocate the purchaser’s sales tax obligations. Still, the ease of mobility of the workforce will present problems with workers who can literally work anywhere and may work in multiple locations at different times.

On the vendor side of the transaction, a provider of services may have to know where his workers are working because the provision of those services could be subject to sales tax in some states but not others. A classic example would be information services or data processing services, which are taxable in only a handful of states. An employer may be surprised to learn that activities that are not taxable in its primary work location might be taxable in some of the states in which its WFA employees work, and it should be prepared to determine whether its revenues might be subject to sales tax in a WFA location of its employees. Conversely, businesses that procure software and information services may find sales tax savings because of the new WFA locations of their workers. If businesses are used to procuring software or information services in jurisdictions with high tax rates, they may realize tax sales and use tax savings (and even effective exemptions) by leveraging the new, broader worker profile from WFA arrangements.

Gross Receipts Taxes?

A number of key state and local jurisdictions impose taxes based on gross receipts. Among the states, Washington’s business and occupation tax, the Nevada commerce tax, and the Ohio commercial activity tax are examples, while many local jurisdictions in California, including Los Angeles and San Francisco, impose similar taxes based on gross receipts derived from activities in those jurisdictions. The sourcing rules for these types of taxes sometimes differ from those regarding sales tax described earlier. Moreover, they typically have broader application than a sales tax with few exemptions or exclusions. Consequently, employees who begin to work on a WFA model in these locations can affect the gross receipts filing obligations of their employers. Similarly, sellers of products and services to WFA workers in these states should be on the lookout for potential tax liabilities incurred by making sales to workers who formerly worked in locations that don’t impose these kinds of business taxes.

State Unemployment Taxes and Labor Laws — Where Do We Go?

The new WFA environment may also require a change in unemployment tax reporting. In yet another way to avoid duplicate state taxation, through incentives provided in the Federal Unemployment Tax Act,8 the nation’s system of state unemployment insurance tax laws typically limits state unemployment tax reporting to a single state, reflecting FUTA’s New Deal 1930s origins, when nearly all workers worked at fixed locations.9 If the primary work location now shifts to a WFA location (or, even more intriguingly, if there is no primary work location and it changes throughout the year), the designated state for each worker may have to change unless the federal or state laws are altered to provide greater clarity.10 Likewise, application of state labor laws, such as wages and hours laws, paid family leave, differences among the states in worker classification matters, training assistance, and any number of other employment issues will arise and have to be addressed.

State Residency and Income Tax Withholding Residency Questions

States clearly have authority to impose tax on all the income of their residents, no matter where earned. Next, nonresident states typically have the authority to impose tax on nonresidents’ income derived from activities conducted within the state. That’s the simple part. Layered over these truisms are a bunch of complications. First, what determines residency? Most states apply a qualitative analysis that looks to the intent of the taxpayer to deem one state his or her state of residence. These states look to the location of one’s home, where the taxpayer is registered to vote, where their mail is delivered, where their children go to school, and so forth.11 Some other states by statute expand the residency rule to include a more objective analysis, such as looking to the number of days a worker is present in the state along with having a place of abode. For example, New York state12 and New York City13 each apply a 183-day-or-more measure for individuals who also have a place of abode there, while in Ohio, the measure is 212 “contact periods” (essentially days) for the establishment of statutory residency.14 In most cases, even spending an hour in the state on one’s own personal activity counts as a full day. The cases in New York are legion,15 and suffering through a residency audit in the state can be both time consuming and frustrating if the taxpayer is not armed with evidence to counter an auditor’s claim of statutory residency. That’s because the burden of proof is on the taxpayer based on “clear and convincing evidence” (the highest standard of proof in civil cases, and just short of the “beyond a reasonable doubt” standard applied in criminal cases). Notably, a statutory residency challenge can be an enormous problem for highly compensated individuals who may have income from intangibles, capital gains on stock or securities, and other sources they might have otherwise thought weren’t subject to a state’s tax because they could not have foreseen that their presence in the jurisdiction created a residency problem. Thus, it’s possible for a taxpayer to have more than one “resident” state, which can result in a double tax without an ability to claim a resident tax credit in either state as an offset.

Convenience of the Employer

Much has been written lately about the “convenience of the employer” tests that some states have imposed, including my January 2021 article in Tax Notes State.16 During the pandemic, New Hampshire famously sued Massachusetts in the U.S. Supreme Court for Massachusetts’s “temporary” regulation mandating that employers continue to withhold Massachusetts income taxes for any employee whose primary work location before the imposition of the pandemic restrictions was in the commonwealth.17 The Court rejected Massachusetts’s petition presumably on grounds of lack of standing.18 The Court’s rejection of this action doesn’t mean that taxpayers aren’t affected, and the same principles that seem to require that states only tax either all the income of their residents or the income of nonresidents that was earned from within the state should indicate that Massachusetts’s rules may have overstepped the constitutional limitations.

New York has long had a similar rule, and nonresident taxpayers have nearly always lost their challenges to the rule.19 Often forgotten about the rule, however, is that it was originally intended as an antiabuse rule for New Jersey and Connecticut commuters to offices in New York City who, in the Mad Men days, could argue that they were actually working from home on Saturdays and Sundays, giving them a potential two-sevenths tax deduction unavailable to New York state residents since neither commuting state imposed a state personal income tax until 1976 and 1992, respectively.20 Thus, when looked at through that lens, the New York convenience of the employer rule really is grounded in fair apportionment and not outright allocation solely because of the primary work location. In fact, New York published its views on what factors would suggest that the employee had a work location outside the state.21 For employers and employees alike, obtaining reliable evidence of an employee’s work location could go a long way to successfully challenge the absolutism of the New York convenience of the employer rule.22

Property Tax Valuation Implications?

Real property taxes are wholly dependent upon value. If the value of commercial property is dependent upon the income generated from services performed by employees at that location, what if the employees on WFA arrangements aren’t there anymore? It appears that the employer (and its lessor) would have pretty good evidence of a decline in value of the property, and therefore evidence of a need to revalue and reassess the property for real property tax purposes. Conversely, if a significant number of employees whose primary work location was in a state without a business personal property tax (for example, New York or New Jersey) begin a WFA assignment in a state with a business property tax (for example, Texas, Florida, or California), the aggregate value of the property of those employees within the jurisdictions could generate personal property tax obligations that didn’t previously exist. In California, for example, business personal property tax is not required to be reported unless the aggregate value of the property exceeds $100,000. It’s easy to see that just 50 remote workers with computers, printers, and associated communications equipment valued at $2,000 each would cause the employer to have to file annual personal property tax returns for that property.

Credits and Incentives — Use ’Em or Lose ’Em?

Less obvious, but no less substantial, will be whether and how employers qualify for various credits and incentives that are dependent upon the work location of the eligible employees. Louisiana, for example, has enacted a “nomad” employee law (effective January 1, 2022) that basically provides a complete but temporary exemption from the state’s personal income taxes for remote workers who relocate to the state.23 Again, in a surprising response to the mobile workforce, other state and local governments provide direct bonuses to workers who relocate to the state or local community.24

On the other hand, an employer may have qualified for a multiyear series of tax credits that was conditioned upon the retention of a minimum number of workers working within the state. If now some of those workers are working remotely from outside the state, the employer could lose some or all of those benefits — or worse, could be subject to a clawback of benefits previously provided.

Brave New World or a Better Way to Work?

I’ll be the first to acknowledge that this list is just a start of the SALT complications arising from the WFA model. Many of the problems have existed forever, but the urgency to respond now is because of the exponential increase in the number of workers who will choose to work this way and their employers who’ll see the enormous benefits from WFA and find that they have no other choice but to accommodate those workers. Nevertheless, employers and employees will have to adapt to their SALT responsibilities. The problems are not impossible to overcome but will require management and the deployment of processes, procedures, and, yes, mobility applications and software that can be used to accurately and correctly report SALT obligations.

FOOTNOTES

1 In addition to this article, readers are encouraged to review two other recent fine articles on this topic: Drew VandenBrul and Jennifer W. Karpchuk, “Remote Work Creates a Spectrum of State and Local Tax Issues,” The Tax Adviser, Dec. 1, 2021; and Lorraine E. Cohen et al., “The New Normal of Remote Work and the Impact on State Filing Obligations,” Tax Notes State, Jan. 3, 2022, p. 7.

2 Compare, e.g., Cal. Rev. & Tax. Code section 23101 (defining “doing business” for purposes of the California corporate tax law and establishing a threshold of $50,000 of payroll or property, $500,000 of sales in California (subject to annual increases tied to the local consumer price index), or 25 percent of the business’s payroll, property, or sales in California) with Cal. Rev. & Tax. Code section 6203(c)(4) (defining “retailer engaged in business in this state” for purposes of the California sales tax to include not just physical presence tests, but also a sales threshold of $500,000 to customers in the state).

3 See, e.g., OECD, “Model Tax Convention on Income and on Capital: Condensed Version 2017,” at 31-33 (Article 5: Permanent Establishment) (as it read on Nov. 21, 2017).

4 15 U.S.C. section 381.

5 46 U.S.C. section 11108 (limiting state income tax withholding on compensation paid to workers on vessels engaged in foreign or interstate commerce to the worker’s resident state); and 49 U.S.C. section 40116 (providing similar limitations on state income taxation of compensation paid to specific airline workers).

6 4 U.S.C. section 114 (limiting taxation of retirement income (e.g., pensions, IRAs, 401(k) plans) to the resident or domiciliary state of the retiree).

7 For an example of a current “multiple point of use certificate,” see Massachusetts Department of Revenue, “Form ST-12: Exempt Use Certificate,” Rev. 11/13, at Item 9.

8 P.L. 76-379 (codified, as amended at 26 U.S.C. sections 3001-3009).

9 Charlie Kearns, “COVID-19 State Employment Tax Considerations — Part II: Unemployment Insurance Taxes,” Tax Mgmt. Memorandum (June 22, 2020) (“While not included within FUTA, the vast majority of states (and Canada) have long-adopted standard rules — the ‘localization of work’ provisions — that determine the state where wages must be reported and [unemployment insurance] taxes paid. The purpose of this uniformity is to ‘cover under one state law all of the service performed by an individual for one employer, wherever it is performed.’”). (Footnotes omitted.) Under these state laws, employers must consider four basic factors when determining the localization of employment coverage (in order of importance): (1) the place where services are localized, (2) the site of the employee’s base of operations, (3) the employee’s place of control, and (4) the employee’s residence. See, e.g., N.Y. Lab. Law sections 511.2 and 511.3 (defining employment for services rendered both within and without the state using the four-factor test). This uncharacteristic uniformity of the unemployment tax laws of the states was achieved through application of a federal tax incentive: Employers in states and jurisdictions complying with federal requirements (including the sourcing of wages) are able to reduce the applicable net federal unemployment insurance tax rate on wages paid to their employees from 6 percent to 0.6 percent. See IRC sections 3303, 3304, and 3305(j). See U.S. Department of Labor, Unemployment Insurance Program Letter 20-04, “Localization of Work Provisions — Principles for Determining Where Wages Should Be Reported When Work Is Performed Entirely in One State or in a Number of Different States (Attachment I)” (May 10, 2004).

10 Before the pandemic, states generally avoided answering questions regarding how unemployment sourcing definitions apply in circumstances of teleworkers. But see Gundecha v. Board of Review, 441 N.J. Super. 339, 345 (App. Div. 2015) (holding that the state in which a telecommuter wholly performs services is the state in which their services are localized regardless of which office the employee telecommutes to). Essentially, if this ruling is followed elsewhere, employers will be on their own in deciphering whether the level of services performed by a telecommuter in a state is sufficient for that state’s unemployment insurance law to attach.

11 See, e.g., California Franchise Tax Board, “2020 Guidelines for Determining Resident Status,” Publication 1031, at 5 (G. Guidelines for Determining Residency).

12 See N.Y. Tax Law section 605(b)(1) (defining “resident individual”); New York Department of Taxation and Finance, “Frequently Asked Questions About Filing Requirements, Residency, and Telecommuting for New York State Personal Income Tax,” at “Can I be a resident of New York State if my domicile is elsewhere?” (updated June 30, 2021); and New York Department of Taxation and Finance, “2014 Nonresident Audit Guidelines” (June 2014). See also Timothy P. Noonan and Kristine L. Bly, “The Nuts and Bolts of New York’s 548-Day Rule, Revisited,” Tax Notes State, Oct. 18, 2021, p. 283.

13 N.Y.C. Admin. Code section 11-1705(b)(1) (defining a “city resident individual”). One of my all-time favorite tax articles, see an entertaining discussion of a New York City nonresident tax audit: James B. Stewart, “Tax Me if You Can,” The New Yorker, Mar. 19, 2012, describing the successful challenge of a residency audit by New York City against one of the famous New York hedge fund managers, resulting in a $27 million refund to the taxpayer. It is astonishing (and gratifying) to see what he did with the refund.

14 Ohio Rev. Code sections 5747.01(I)(1) (defining “resident”) and 5747.24(B) (which modifies the general term of “resident”).

15 Just take a look at the pages (and pages) of annotations of residency case summaries at N.Y. CLS Tax section 605, Annotations Part III, “Residence for Tax Purposes.” Frustratingly, all seemingly efforts in futility by the taxpayers.

16 Steven N.J. Wlodychak, “New Hampshire v. Massachusetts: Wrong Court, Right Case,” Tax Notes State, Jan. 11, 2021, p. 107.

17 830 Mass. Code Regs. 62.5A.3: Massachusetts Source Income of Non-Residents Telecommuting Due to the COVID-19 Pandemic (Emergency Regulation) (last updated Mar. 5, 2021).

18 New Hampshire v. Massachusetts, 141 S. Ct. 2848 (2021).

19 N.Y. Comp. Codes R. & Regs. tit. 20, section 132.18(a) (“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.”).

20 See Zelinsky v. Tax Appeals Tribunal, 1 N.Y.3d 85, 92 (2003) (“The [New York] convenience [of the employer] test was originally adopted to prevent abuses arising from commuters who spent an hour working at home every Saturday and Sunday and then claimed that two sevenths of their work days were non-New York days and that two sevenths of their income was thus non-New York income, and either free of tax (if the state of their residence had no income tax) or subject to a lower rate than New York’s.”).

21 New York Department of Taxation and Finance, “New York Tax Treatment of Nonresidents and Part-Year Residents Application of the Convenience of the Employer Test to Telecommuters and Others,” TSB-M-06(5)I (May 15, 2006). The guidance describes a menu of conditions, including primary factors, secondary factors, and “other” factors, that must be established to avoid sourcing income back to a “primary work” location in New York.

22 In Huckaby v. New York State Division of Tax Appeals, 4 N.Y.3d 427, 829 N.E.2d 276 (2005), a sharply divided New York Court of Appeals (4-3) determined that the convenience of the employer test required a Tennessee resident working remotely to assign 100 percent of his income to New York. Judge Smith in dissent wrote that the test was an apportionment view and that he would have found it unconstitutional. 4 N.Y. 3d at 440-449.

23 See 2021 La. Acts 387 (2021 La. S.B. 31).

24 See Jessica Thomas, “8 U.S. Cities and Towns That Will Pay You to Move There and Work Remote in 2021,” Entrepreneur, Apr. 26, 2021 (describing grant programs from communities such as Natchez, Mississippi; Northwest Arkansas; and Topeka, Kansas, offering cash grants to individuals who relocate there).

END FOOTNOTES

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