Continued challenges involving teleworking employees: The new normal

Editor: Carolyn Quill, CPA, J.D., LL.M.

Co-editors: Richard Mather, E.A., MSA, CAA; Jonathan McGuire, CPA; and Kathleen Moran, CPA, MBA, MT

Teleworking is not new, but the COVID-19 pandemic brought with it a spike in remote work arrangements. From January 2020 to September 2021, the average share of postings on job websites mentioning remote work nearly tripled. While initially associated with the introduction of pandemic-related work and travel restrictions, the average share of remote job postings has remained near the peak it first reached in April 2021. States and localities initially issued guidance generally providing for a status quo method of taxation for nonresident employees working traditionally in their states. But many states began to struggle with the longer-term effect of telecommuting employees who no longer physically worked within their jurisdictions.

The question became whether states may legally tax the income of nonresidents who begin telecommuting on a long-term basis, as the COVID-19 pandemic and telework continued. Further state guidance in the form of various filing relief measures for employees working from home followed in June and December 2021. By August 2022, however, most of these filing protections had expired.

Complications continue to arise, with each state making its own tax rules. In most states, a nonresident employee’s income is sourced based on the employee’s physical presence or location. Yet some states have adopted a “convenience rule,” which turns on the reason an employee is working out of state. If the employer requires the employee to live out of state for purposes of work (at the employer’s convenience), then the employer must withhold taxes for the state where the employee works. On the other hand, if an employee chooses to live in another state for his or her own personal reasons, then an employer must withhold taxes for both the state of the employer and the state where the employee is a resident; i.e., where the employee performs the work. States with a convenience rule include Arkansas, Connecticut, Delaware, Nebraska, New York, and Pennsylvania. In each of these states, if the employee is working out of state at the employer’s convenience, then the employer only withholds taxes for the state in which the work was performed.

Further complicating the issue, some states have reciprocal tax agreements, which allow residents of one state who work in another state, often a neighboring state, to avoid filing a nonresident state tax return. Currently, 16 states have some type of reciprocal agreement. In these states, the employer withholds tax for the state where the employee lives, rather than for the state where the employee works. It is important to note that neighboring states are not the only states to have reciprocal agreements, and many neighboring states do not have reciprocal agreements at all. It is thus vital for employees and employers alike to remain informed regarding the income tax rules of both the state of the employer and the state of the nonresident employee.

The adoption of certain tax policies involving remote work has already resulted in disputes between neighboring states. On Oct. 19, 2020, New Hampshire requested that the Supreme Court exercise its original jurisdiction in evaluating the constitutionality of a temporary Massachusetts tax rule, which required certain nonresident employees of Massachusetts employers to treat income earned for services performed in another state because of COVID-19 as if the income had been earned in Massachusetts. In a press release announcing the filing of the lawsuit, New Hampshire’s governor called Massachusetts’s temporary tax rule an “unconstitutional tax grab.” On Jan. 25, 2021, the Supreme Court invited the acting U.S. solicitor general to file a brief in the case, in which she argued that this was not an “appropriate case for the exercise of this Court’s original jurisdiction.” The Supreme Court eventually declined to hear the case (see New Hampshire v. Massachusetts, No. 22O154 (U.S. 6/28/21)), and the temporary tax rule expired shortly thereafter. Employees working remotely continue to present a variety of tax-related issues for companies. The relationship between the state where an employee works and where she resides remains a key consideration from a payroll and withholding tax perspective.

In Congress, at least two bills are pending as of this writing regarding a state’s ability to tax the income of a nonresident. First, the Remote and Mobile Worker Relief Act of 2021, S. 1274, was introduced in the Senate on April 21, 2021. Under this bill, income earned by an employee who lives in one state and works in another would only be taxed by the state of residence or any state in which the employee is present and working for more than 30 days. On May 27, 2021, another bill was introduced in the Senate called the Multi-State Worker Tax Fairness Act of 2021, S. 1887, under which a state would only be allowed to tax the income of a nonresident if the nonresident is physically present in the state. Both bills have been referred to the Senate Finance Committee for consideration.

As teleworking is only expected to continue, it will be crucial for both employers and employees to understand the income tax laws of all states in which there are remote workers, including any reciprocal agreements between states. Unless federal action is taken, a patchwork of state laws will continue to govern how remote working affects an employer’s tax withholding obligations for the foreseeable future.

Editor Notes

Carolyn Quill, CPA, J.D., LL.M., is the lead tax principal at Thompson Greenspon in Fairfax, Va. Richard Mather, E.A., MSA, CAA, is a director at EFPR Group in Rochester, N.Y.; Jonathan McGuire, CPA, is senior tax manager at Aldrich Group in Salem, Ore.; and Kathleen Moran, CPA, MBA, MT, is a director at Pease Bell CPAs in Cleveland. Unless otherwise noted, contributors are members of or associated with CPAmerica Inc. For additional information about these items, contact Carolyn Quill at taxclinic@cpamerica.org.