Diagnosing the SALT effects of COVID-19: Part 1

By Carolyn Puzella, J.D., LL.M.

Editor: Bridget McCann, CPA

The novel coronavirus (COVID-19) pandemic that spread across the United States in early 2020 created a once-in-a-lifetime public health emergency that necessitated unprecedented reaction from federal and state governments, businesses, and individuals. State governors quickly began declaring states of emergency, completely shutting down nonessential businesses and implementing public stay-at-home orders — forcing many employees out of jobs and other employees into their homes and outside their normal workplaces, faced with the sudden prospect of teleworking. For safety protection, the need for personal protective equipment (PPE) soared, and businesses sitting on inventory used and donated it. Other businesses shifted traditional manufacturing or retail operations to make and sell PPE and hand sanitizer.

Almost immediately, taxpayers sought administrative relief from looming federal and state tax filing and payment deadlines and changes to established ways of doing business, as they struggled to adjust to life at home, to prohibited in-person interactions, and to missing basic office resources. As the situation became increasingly dire and the need for broad financial relief became clear, federal and state tax deadlines moved and extensive federal legislation passed, anchored by the Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136, and its provisions for the Paycheck Protection Program (PPP).

Quickly thereafter, extremely important questions of state taxation evolved: Will each state conform to all, some, or none of the CARES Act provisions? Will any state treat PPP loan proceeds or forgiven loan amounts as income? What effect will COVID-19 teleworking employees have on state nexus and apportionment positions? In what state should an employer withhold payroll tax and an employee pay income tax when work is now performed remotely? What are the indirect tax implications of distributing PPE or manufacturing and selling hand sanitizer? What if a business cannot expand employee headcount as planned — will agreed-to local incentive arrangements be flexible and forgiving?

The speed with which state governments were forced to respond to this unique crisis and contend with so many new questions, not surprisingly, resulted in an assortment of both formal legislative and informal administrative guidance across states on unprecedented state tax matters, some of which has yet to be clarified or otherwise codified by legislation. Indeed, guidance is absent altogether in many cases, and many new questions still need to be asked. This column explores these initial questions and certain state and local guidance to date and outlines what taxpayers can expect next as states look to replace lost revenue and consider new opportunities to support taxpayers and streamline outdated procedures. Part 1 looks at state conformity to certain CARES Act relief, nexus and apportionment issues affecting businesses, and income tax issues for individuals. Part 2, in the October issue, will review sales-and-use tax consequences, local property tax matters, and discuss what is next for taxpayers and state and local governments. Undoubtedly, the coronavirus pandemic will have a deep, widespread, and long-lasting impact on the state and local tax landscape.


The most significant piece of relief legislation passed in the early months of COVID-19 is the CARES Act, which was signed into law on March 27, 2020. In addition to a host of much-needed economic relief provisions, the CARES Act includes changes to three major Code provisions aimed at improving cash flow for both business and individual taxpayers. First, for Sec. 172 net operating losses (NOLs), the CARES Act suspends the 80% taxable income limitation for tax years beginning after Dec. 31, 2017, and before Jan. 1, 2021. It also provides for a five-year carryback of NOLs that arise in tax years 2018, 2019, and 2020.

Second, regarding Sec. 163(j) business interest expense, the CARES Act loosens the deduction limitation by increasing the 30% adjusted taxable income (ATI) threshold to 50% for tax years beginning in 2019 and 2020, with additional special rules for partnerships. Third, relative to Sec. 168 qualified improvement property (QIP), the CARES Act designates eligible QIP placed in service after Dec. 31, 2017, and before Jan. 1, 2023, as property with a 15-year MACRS (modified accelerated cost recovery system) recovery period — thereby qualifying it for 100% bonus depreciation in the first year — and a 20-year ADS (alternative depreciation system) recovery period.

The CARES Act also provided critical relief through nontax provisions. Sections 1102 and 1106 of the act created the PPP, under which certain taxpayers are afforded small business loan support through the U.S. Small Business Administration (SBA) and may obtain forgiveness of up to the full loan amount if certain conditions are met. Plus, to directly support individual taxpayers, Section 2201 of the CARES Act provides for direct economic impact payments to those meeting certain income criteria — most of which have been distributed. Each relief provision raises pressing state tax concerns, stemming in large part from each state's compliance or noncompliance with them.

State conformity to CARES Act relief

Most states rely in some form on the Code for administrative ease, but they do not automatically conform to all its provisions and, therefore, may or may not conform to every Code-related provision of the CARES Act. In general, states conform to the Code in one of three ways: (1) rolling or automatic conformity; (2) static conformity — conformity as of a specific date; or (3) selective conformity — conformity to only certain sections or definitions. To ultimately determine state conformity to Code provisions, taxpayers must know each state's Code conformity method, legislative or other administrative modifications to specific Code sections, and the application of conformity methods and modifications to different types of taxpayers (i.e., business entities vs. individuals). This creates a tremendous amount of complexity, further muddied by years of inconsistent federal and state treatment.

In addition, and very importantly, several CARES Act provisions — such as the PPP and its loan forgiveness provisions — are not in fact tied to the Code, so states' rolling, static, and selective general conformity regimes are not squarely applicable. Not surprisingly, therefore, whether a state will conform to any of the CARES Act economic relief provisions depends on each state's existing tax code and overarching federal conformity regimes, as well as targeted legislative and administrative guidance.

Relative to the CARES Act tax provisions, state conformity to date is varied — in part because of limited explicit guidance. As an example, Illinois generally conforms to the Code on a rolling basis, and therefore it adopts most Code provisions, unless otherwise modified. Given the current absence of specific legislative action and administrative guidance as to the adoption of specific CARES Act tax provisions, Illinois will conform to the tax provisions of the CARES Act, but with modifications. As a result, Illinois will conform to its loosened Sec. 163(j) business interest expense limitation and new 50% threshold as well as its 100% bonus depreciation for QIP. Further, more generally, Illinois will conform to CARES Act provisions that affect individual federal adjusted gross income (AGI), since it uses federal AGI as a starting point for state taxable income calculations. However, like many other states, Illinois will not conform to the CARES Act business NOL provisions. Instead, Illinois will retain its treatment of business NOLs, not allowing any carryback and allowing only a 12-year carryforward.

While New York also historically conforms to the Code on a rolling basis, its 2020—2021 Budget Act enacted on April 3, 2020, specifically decouples the state from the CARES Act's 50% business interest expense threshold and creates static Code conformity temporarily, indicating that for tax years beginning before Jan. 22, 2022, any amendments to the Code after March 1, 2020, will not apply for personal income tax purposes. Accordingly, based on its Code conformity regime, New York will decouple from the CARES Act's NOL provisions, business interest expense limitation relief, and QIP depreciation changes. Ohio, on the other hand, declared it is in full conformity with federal income tax law as it existed on March 27, 2020, including the CARES Act and its applicability to Ohio's income taxes. Notably, determining conformity to these three main CARES Act tax provisions in many states is further complicated by pre-COVID-19 conformity — or lack thereof — to the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97.

Administratively with respect to the carryback of NOLs, if a state does allow for the carryback of losses in conformity with the CARES Act, taxpayers will likely need to file amended state returns to obtain this benefit. In the absence of specific CARES Act-related state guidance, existing relevant state amended return and income tax refund claim rules (for example, rules regarding timing and limitations) govern. Thus, state rules may not line up with federal rules due to years of disparate treatment in this area. Also relative to NOLs, while some in the market may push for the option to cash out NOLs as a source of liquidity for taxpayers amid the ongoing economic stress caused by the pandemic, states may not be so quick to oblige.

As for the PPP and its loan forgiveness provisions, it is important to first point out that under Section 1106(i) of the CARES Act, any forgiven loan amount is specifically excluded from federal gross income. Since the PPP loan forgiveness provisions and corresponding income tax treatment are not specifically aligned with any Code section, however, it is unclear whether the canceled debt will be considered income for state income tax purposes. Certain states, though, do currently provide some initial guidelines.

Hawaii, for instance, indicates that PPP loan proceeds are not taxable; however, forgiven PPP loan amounts are subject to Hawaii income tax and general excise tax. Iowa, on the contrary, says forgiven PPP loan amounts are not included in income. Washington, while agreeing with Iowa, is taking a more temporary approach, stating it will not impose its business and occupation tax on federal financial assistance that businesses receive in response to the COVID-19 pandemic, until the state Legislature addresses the federal programs. Ohio, as a last example, confirmed forgiven PPP loan amounts are not subject to its commercial activity tax.

Finally, regarding federal economic impact payments (i.e., refundable recovery rebate income tax credits) authorized and issued under the CARES Act, the question is whether such payments will be subject to state personal income tax. Some states, like California, Hawaii, Iowa, and Wisconsin, for example, provide clear guidance that such payments will not be subject to their personal income tax. Oregon agrees and specifically considers them advance payments of federal refundable credits. In states with no explicit guidance, however, the answer may not, again, be so clear.

Business income tax nexus and apportionment

Meaningful state income tax issues around nexus and apportionment emerged from both early and ongoing stay-at-home orders to mitigate the spread of the coronavirus. With respect to nexus, concerned business taxpayers asked whether an employee forced to shelter in place and teleworking in another state, or in another local jurisdiction, outside of their normal office location would trigger — by itself — income tax or gross receipts tax nexus. Other taxpayers in the business of selling tangible property wanted to know if their teleworking employees would dilute or otherwise eliminate any "no nexus" positions historically based on the protections afforded by P.L. 86-272, the Interstate Income Act of 1959. And still others sought to understand the effect such teleworking employees would have on factor presence economic nexus thresholds.

As office buildings remained closed and employees continued to work remotely, many states began offering specific guidance. Minnesota and Pennsylvania both said they will not seek to impose nexus on out-of-state businesses solely because an employee is working remotely in the state on account of COVID-19. Massachusetts agreed and issued Technical Information Release 20-10 on the subject. Local jurisdictions such as Philadelphia weighed in, indicating nexus is temporarily waived for these reasons. Further, Indiana and Massachusetts specifically indicated that pre-COVID-19 P.L. 86-272 protections would not be lost as a result of a temporarily relocated teleworking employee engaging in more than solicitation activities. Importantly, however, looking deeper into the guidance across states, relief is likely only to be effective during a certain period of time — for example, in Indiana effective only during the COVID-19 pandemic, with the temporary protections extended for periods of time where an official work-from-home order issued by an applicable federal, state, or local governmental unit is in effect or per the order of a physician in relation to the COVID-19 outbreak, or from an actual diagnosis plus 14 days.

Regarding apportionment, while states are trending away from using a traditional three-factor apportionment formula consisting of property, payroll, and sales for income division, some states still use this historic calculation method, particularly for certain specialized industries and/or for certain taxpayers (e.g., partnerships), either on a mandatory or an elective basis. The question of whether wages and other compensation of a COVID-19 teleworking employee should be included in the payroll factor is a real one. Massachusetts, for example, said it would not require such an inclusion for the duration of the COVID-19 state of emergency. North Dakota concluded the same, as long as the situation is intended to be temporary.

Likewise, whether employer-owned home office equipment provided to a remote employee on account of COVID-19 should factor into the property calculation is also relevant. The answers will unquestionably depend on each state's specific statutory, regulatory, and administrative guidance and, perhaps, ultimately on the "temporary" nature of the remote work altogether, however defined.

With respect to sourcing revenue for sales factor purposes, states are trending toward a market- or customer-based sourcing regime, but some states and localities continue to rely on long-standing cost-of-performance rules for either all taxpayers or certain taxpayers, certain revenue streams, and/or certain industries. Beyond nexus and apportionment formulas, unwitting business taxpayers may be further blindsided by failing to consider material costs of COVID-19 teleworking employees or the location from which these employees perform services, which could have a material consequential effect of shifting income between high- and low-tax states.

Philadelphia, for example, affirmed that receipts from services performed by resident employees temporarily working at home solely as a result of the COVID-19 pandemic will not be sourced to the city for purposes of its business income or its net profits tax. However, the city also maintained that receipts sourced to Philadelphia before COVID-19 will remain city receipts, even if employees are temporarily working outside the city on account of COVID-19. Finally, what about the effect of COVID-19 teleworking employees on positions for avoiding throwback or throwout under rules for capturing receipts sourced to no-nexus jurisdictions? Could these teleworking employees create state nexus now if a business wanted them to? Indiana and Massachusetts say likely no, and other states may ultimately have limited to no guidance on the matter.

Notably, since many state legislatures were suspended, postponed, or otherwise adjourned because of the pandemic, early nexus and apportionment guidance was — and in many cases still is — in the form of frequently asked questions on state revenue department websites, which do not have the effect of law. Of course, since these analyses depend on each taxpayer's unique set of facts, nexus determinations and apportionment calculations will therefore turn on any number of traditional and/or COVID-19-specific factors as well as evolving state guidance. Definitions and the source of guidance will be critical for any state analysis here — a time frame that is considered "temporary" for one state is not likely to be temporary in all other states, for example.

Employer and employee personal income tax matters

In the majority of states with a personal income tax, withholding and other income tax questions also quickly materialized for both employers and employees as a result of the sheer number of personnel sheltering in place and working remotely in their own primary home, a vacation home, or a relative's home, away from their main office in compliance with states' emergency orders. As time went on for employers, it became less clear in what state income tax withholding on teleworking employee wages should occur — in the state of an employee's normal base of operations or the state in which the employee is now physically located, or both — and, if a change needed to be made, when the new obligation starts and ends. Also relevant is the question of how practically an employer manages these state requirements amid a global pandemic, particularly if the employee chooses to move around between various locations.

The guidance so far in this regard is nuanced and far from uniform. Massachusetts, for example, issued an emergency regulation (830 Code Mass. Regs. §62.5A.3), specifying that employers already withholding tax on Massachusetts-source income of nonresidents immediately before the COVID-19 state of emergency are required to continue withholding tax on that income, even if those nonresidents are working outside Massachusetts during the emergency. Massachusetts also added that an employer is not obligated to withhold income tax for a Massachusetts resident now teleworking in the state during this same time frame, if the employer is required to withhold income tax with respect to that resident in the other state in which the employee incurred an income tax liability before shelter-in-place orders went into effect. Illinois, however, takes a different stance in light of new withholding rules that took effect Jan. 1, 2020. While Illinois will waive penalties and interest for out-of-state employers that fail to withhold Illinois income tax on resident employees working at home, where the "sole reason for the Illinois withholding obligation" is a resident employee working from home "due to the COVID-19 pandemic," it instructs those employers and others with employees working in Illinois more than 30 days to begin withholding income tax as soon as applicable.

Similarly, in Maryland, since employer withholding is based on the physical presence of employees, the state will generally require employers to withhold income tax for nonresident employees teleworking in the state. Finally, all of this is further complicated by personal income tax reciprocity and/or convenience-of-employer rules in and among a number of states that either limit or expand employer withholding requirements like those above.

Employees physically present in states by virtue of teleworking during the pandemic, relative to which they otherwise would have no job connection, realistically face the prospect of double taxation. In addition to paying personal income tax on all earned income to the state in which they reside, a COVID-19 teleworking employee may also owe income tax to the state in which he or she was, or still is, working, if different, based on how long the employee is present. Importantly, double tax is paid in many cases without appropriate credits of tax between states, either because credits are not available — or are not clearly available for COVID-19 mobile employees — or individual tax rates between states are not in the employee's favor. As a result, a substantial number of employees are now forced to navigate and understand these complex income tax credit rules; number of working day thresholds that trigger personal income tax liabilities; and like employers, state reciprocity agreements that create nonuniformity across otherwise similarly situated taxpayers.

Resembling new guidance for employers, initial guidance for employees is equally inconsistent between states. For instance, although Massachusetts confirmed residents are required to pay personal income tax on all income even if they are teleworking outside the state during the COVID-19 emergency, it will provide Massachusetts residents suddenly working at home because of COVID-19 and continuing to incur an income tax liability in another state because of that other state's sourcing rule a credit for income taxes paid to that other state.

New York and California, however, are expected to impose personal income tax on remote employees working in their state on account of COVID-19, based on their historic number-of-working-days rules — and New York is even expected to include health care workers who went there to provide much-needed patient care. Likewise, in Illinois, even COVID-19 teleworking employees who do not have Illinois income tax withheld by their employers could potentially owe money to the state and may, in fact, be subject to estimated tax payment requirements if they surpass the new 30-working-day rule.

Yet, apart from COVID-19-specific state relief and guidance, in many respects, the key to employee personal income tax obligations in the longer term is likely, at least in part, to turn on each state's definitions of "resident" and "nonresident" and the application of those definitions to employees teleworking between states before, during, and after the pandemic. The language of new COVID-19-related guidance relies on these terms but leaves out direction on key determining factors, such as the common 183-day presence standard, under which individuals can transition from nonresident to resident status if surpassed. As COVID-19 teleworking employees approach the six-month mark — and 183 days or more — in a new state, they could face an entirely new set of state personal income tax concerns as both a resident of one state and a domiciliary of another state, almost surely to result in double taxation without the eligibility for tax credits.

Some remote employees, on the other hand, could end up qualifying as residents of states that do not have an income tax and come out winners. For COVID-19 teleworking employees, documenting the number of days present in the different states in which they traveled, stayed, and worked will be key. In this regard, while this is a very fact-intensive analysis, it is not implausible to wonder if questions of domicile will emerge down the road for certain employees who continue to stay away from the office and work remotely as the threat of COVID-19 subsides, either at the encouragement of their employer or by choice. While many of these issues are not new, they are wildly cumbersome and intertwined and place enormous new burdens on a substantially larger population of remote and mobile workers and their employers.

In an effort to provide certainty and uniformity throughout the country, Congress is considering federal legislation: S. 3995, the Remote and Mobile Worker Relief Act of 2020. Generally, the bill seeks to provide uniformity for nonresident state and local personal income tax withholding and specifically proposes a reasonable de minimis exception from the assessment of state and local personal income tax in a jurisdiction in which an employee does not reside, but to which he or she travels and works. The bill also outlines a framework to address many of the state and local personal income tax issues that arose — and are still arising — from the changing location of employees during the coronavirus pandemic.

The AICPA supports the legislation and urged Congress to enact it. (The AICPA's comment letter is available at aicpa.org.) While the bill is similar to other legislation proposed over the years, the targeted relief language and overarching need for a national standard during the ongoing pandemic may propel this bill to passage.

Finally, of great consequence to employers is the substantial risk of increased unemployment insurance (UI) costs due to layoffs that otherwise could not be avoided amid the pandemic. To allay fears, a number of states assured employers that COVID-19-related layoffs would not be charged against them for purposes of negatively affecting their experience ratings — ratings that drive the UI taxes employers pay to fund unemployment benefits. Other states, however, such as Maryland and Nevada, maintain that despite the public health and economic crisis, employers will in fact be charged for these layoffs. And, even if experience ratings remain steady, other circumstances may cause states to shift to a higher UI tax rate schedule. As a result, employers should closely follow local executive orders and labor department guidance.   



Carolyn Puzella, J.D., LL.M., is director, Indirect/State and Local Tax at FGMK LLC in Chicago.Bridget McCann, CPA, is managing director of State Tax at Grant Thornton LLP in the Philadelphia area. Ms. McCann is the chair of the AICPA State & Local Tax Technical Resource Panel. For more information about this column, contact thetaxadviser@aicpa.org.

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