Companies with more employees working remotely during the COVID-19 pandemic could look to make changes to both withholding and apportionment at the state level.
Kimberly Krueger of PwC said that states initially focused on considerations like conforming to federal tax return filing extensions and how they were going to get returns processed but then shifted their focus to the tax implications of remote work.
Speaking on a panel during the Georgetown University Law Center's 2020 Advanced State and Local Tax Institute August 12, Krueger said an immediate concern is the impact on withholding and whether it should be changed to reflect employees' actual work location. She said several states have issued guidance saying that employers should continue to withhold based on where the employee is typically located in their work office, but added that where employees work from may not be visible to employers and that an employer may not be registered in the state in which an employee is working remotely.
Krueger said several states, including New York, have a “convenience of the employer” rule, which generally says the state has the right to tax all of an employee’s earnings if the employee works outside the state for his or her own convenience. She said that employees were likely not working remotely for their own convenience while shelter-in-place orders were in effect because of the pandemic, but added that as some states reopen and employees continue to work remotely the issue becomes less clear.
She stated that companies that were inclined to continue withholding based on their traditional work office may want to revisit that approach if they decide to delay their reopening strategy, adding that they may see pushback from employees who want to have their withholding reflect their actual work location.
Karl Frieden, vice president and general counsel for the Council On State Taxation, said the council has been pushing for years to get federal legislation like the Mobile Workforce State Income Tax Simplification Act passed so that employees working in a state for 30 or fewer days a year would not create a withholding liability in the state or a requirement that the employee file tax returns in that state. He said he hopes to see some movement on that legislation soon.
Alysse McLoughlin of McDermott Will & Emery agreed that there has been a huge acceleration in telework, adding that more companies are realizing the benefits of having employees working remotely, such as reduced real estate costs. She also noted that there are many issues related to remote work, including tax withholding and apportionment issues.
Krueger said that changes to an employee’s work location also affect nexus for state income taxes and state sales taxes. While she acknowledged that some states have issued taxpayer-friendly guidance that indicates temporary employee work locations will not be considered for nexus purposes, Krueger noted that the guidance is generally temporary, lasting only for the duration of the state’s shelter-in-place mandate.
Noting that roughly a third of states continue to apply some form of cost of performance rule for apportionment, Krueger said there may be some opportunities for businesses to reduce their apportionment in some states, given the actual work locations of their employees. There may be opportunities even in states with market-based sourcing, Krueger continued, giving the example of a company whose receipts are sourced based on where licenses are used by its customers’ employees.
Krueger added that remote work can also affect a company’s payroll and property factor with changes in work locations and expenses like rent. She questioned whether companies will look for relief from the standard apportionment formula that “might not be reflective of their actual in-state business activities.”
But Krueger also said that it is important to note that a lot of companies are expecting losses, given the economic conditions, so apportionment decreases may not be beneficial after considering a state’s treatment of net operating losses.
“The key here is documentation,” Krueger said, stating that companies need contemporaneous documentation like IP addresses or ID card swipes if the office is open to support their position, whether the company's making changes to withholding or to apportionment. “I think without adequate documentation, states may look to throwback payroll or sales to the jurisdiction — to the traditional work location.”
Krueger reiterated that the guidance on these issues tends to be informal and temporary, which she said raises concerns that taxpayers may end up “whipsawed” and essentially double taxed if employees are adjusted to the state that they are actually working from but the state in which they usually work issued guidance for employers to ignore temporary work locations.