With Tax Day in the United States delayed until 17 May, now might be a good time to talk to your clients about how pandemic-imposed working-from-home (WFH) arrangements may affect their tax liabilities.
The income tax system across the United States is something of a patchwork quilt. Of course, the federal income tax applies across the entire country. Yet, each state in the union is a separate sovereign with its own taxing powers.
Not all states impose an income tax, but those that do have their own unique systems for doing so. In addition to state income taxation, many municipalities also have the power to impose an income tax.
With so many taxing authorities, it is no wonder people spend so much time and money trying to determine their correct tax liability and to which sovereign that tax is owed. With many commercial offices having closed as a result of the COVID-19 pandemic, many workers — our clients among them — have been forced to work from home and often their homes are located in a different state or municipality than their now-closed offices.
The relocation of workers and the work that they produce — from office to home — has challenged the various tax systems as states and municipalities try to raise revenue and employers and employees try to determine who has the power to tax the income earned from that work now that the workers are not actually commuting to the office.
Below we provide some discussion points advisers might consider raising with affected clients as 17 May approaches. Of course, the myriad local income tax rules dictate that you encourage your clients to seek the advice of a knowledgeable local tax advisor, if you’re not one yourself, who can help you and your clients resolve these issues.
At its most basic, the question that arises from our unique federal system is whether a state may tax the income of a worker who is employed by, and provides work to, a company in that state, but who never physically sets foot in the state. Of course, this same question can play out within a state that allows its municipalities to impose an income tax. That is, can a town or city tax the income of a worker who is employed by, and provides work to, a company in that town or city, but who never physically sets foot in that town or city?
It is fairly clear that a state can impose a tax on a worker who lives outside of that state but who comes into the state to work for an employer located in the state.1
Of course, governments run on tax revenue and, even before the current pandemic, many states tried to tax income earned by nonresidents working for in-state employers from their out-of-state homes. New York State is a prime example. Imagine a client who works for a company in Manhattan, who lives in Connecticut, and who works part of the time in a New York office and part of the time from home in Connecticut. New York law taxes nonresident employees, as other states do, based only on the portion of the nonresident’s work days in New York.2
Yet, New York considers an employee’s work day as an out-of-state day for tax purposes only if the nonresident is obligated in the service of the employer to work remotely “of necessity, as distinguished from convenience.”3 Thus, if our New York client chooses to work from home rather than out of the employer’s necessity, New York would tax all of that client’s income, notwithstanding that they were working in Connecticut.4
The COVID-19 pandemic has brought this taxing authority question into sharper focus as offices have closed and WFH arrangements have proliferated. For instance, Pennsylvania issued guidance for Pennsylvania employers whose employees are working remotely due to the COVID-19 pandemic. As stated in the guidance:5
“Employees
“In summary, if an employee is working from home temporarily due to the COVID-19 pandemic, the department does not consider that as a change to the sourcing of the employee’s compensation. For non-residents who were working in Pennsylvania before the pandemic, their compensation would remain Pennsylvania sourced income for all tax purposes, including PA-40 reporting, employer withholding and three-factor business income apportionment purposes for S Corporations, partnerships and individuals. . . .
“Employers
“For a Pennsylvania employer with a non-resident employee temporarily working from home due to the COVID-19 pandemic in a state that doesn’t have a reciprocity agreement with Pennsylvania, the department advises that the employee’s compensation remains Pennsylvania sourced, and the employer is required to withhold on the compensation.”
Massachusetts has taken a similar stance in regards to its taxpayers. Pursuant to Massachusetts promulgated emergency regulation 830 CMR 62.5A.3:
“ . . . for the duration of the Massachusetts COVID-19 state of emergency, all compensation received for personal services performed by a non-resident who, immediately prior to the Massachusetts COVID-19 state of emergency, was an employee engaged in performing such services in Massachusetts, and who, during such emergency, is performing such services from a location outside Massachusetts due solely to the Massachusetts COVID-19 state of emergency, will continue to be treated as Massachusetts source income subject to personal income tax under M.G.L. c. 62 and personal income tax withholding.”6
Many workers employed by companies in Massachusetts live in adjacent states, including New Hampshire. New Hampshire does not impose an income tax on salaries and wages and has sought leave to sue Massachusetts in the US Supreme Court7 to prevent Massachusetts from taxing the income of New Hampshire residents who are working from home for Massachusetts employers.8 Massachusetts has characterized its action as simply maintaining the status quo with respect to the administration of its tax system during the COVID-19 emergency.9
With tax filing day rapidly approaching, what should a client employee who must pay income tax or a client employer who must withhold tax do?
For the Client Employer Who Must Withhold Tax
If you lack the expertise, encourage them to seek the advice of a local tax professional who is familiar with the rules for the jurisdictions in which they operate to determine their obligation to withhold income and pay income tax in regards to their employees’ wages.
For the Client Who Must File a Tax Return
Again, if you do not possess the necessary knowledge, advise them to consult a local tax professional who can assist them in determining how much tax they should pay and to which jurisdictions. If the state where they work and the state where they live do not have an agreement as to the imposition of income tax, they may wish to pay tax to the state where they work, notwithstanding that they have not actually been working in that state and, thereafter, file a claim for refund.10
Although this approach may be more expensive, it may be similar to what they would have done in a normal, pre-COVID-19 year. Also, by paying the tax and claiming a refund, they may avoid the imposition of interest and penalties for an underpayment of income tax. A skilled tax professional can help guide you and your clients in making these decisions.
If life hasn’t become complicated enough as we navigate the new world imposed upon us by the COVID-19 pandemic, many of our clients must now unravel the uncertainties of state and local taxation as they are forced to work from home. As with any complicated problem, if you don’t have the expertise, you should seek it out. Help your clients find a tax and legal professional who can help make the appropriate decision for themselves, their families, and their wealth.
1. The Due Process Clause of the U.S. Constitution, U.S. Const. amend. XIV §1, permits a state to tax nonresidents working in that state (but, generally, not outside of the state). A state “generally may tax only income earned within the [state]”, not income that nonresidents earn outside the taxing state’s boundaries. Okla. Tax Comm’n v. Chickasaw Nation, 515 U.S. 450, 463 n. 11 (1995); Shaffer v. Carter, 252 U.S. 37, 57 (1920) (“As to nonresidents, the jurisdiction extends only to their property owned within the State and their business, trade, or profession carried on therein, and the tax is only on such income as is derived from those sources.”); Travis v. Yale & Towne Mfg. Co., 252 U.S. 60, 75 (1920) (the state “. . . has jurisdiction to impose a tax of this kind upon the incomes of non-residents arising from any business, trade, profession, or occupation carried on within its borders, . . . ”).
2. 20 NYCRR § 132.18(a).
3. Id.
4. Such a case was actually litigated in New York. Zelinsky v. Tax Appeals Tribunal, 1 N.Y. 3d 85 (2003), cert. denied, 541 U.S. 1009 (2004). In that case the taxpayer split his time between his office in New York and his home in Connecticut. Perhaps unsurprisingly, New York’s highest court found that the taxpayer was working from home for his convenience, not the necessity of his employer, and imposed its income tax on the taxpayer’s entire income. The United States Supreme Court declined to hear the case. Other states also follow this path, such as Pennsylvania, 61 Pa. Code § 109.8, Nebraska, 316 Neb. Admin. Code § 22-003.01C(1), and Delaware, Del. Code Regs. 31-200-800, Director’s Ruling 71-13.3(b).
5. Telework During the COVID-19 Pandemic, Pennsylvania Department of Revenue, (last accessed 13 February 2021).
6. TIR 20-5: Massachusetts Tax Implications of an Employee Working Remotely due to the COVID-19 Pandemic, Massachusetts Department of Revenue, 21 April 2020 (last accessed 13 February 2021).
7. New Hampshire v. Massachusetts, Docket No. 22O154, Motion For Leave To File Bill of Complaint (last accessed 13 February 2021).
8. New Hampshire seeks to invoke the U.S. Supreme Court’s original jurisdiction with respect to disputes between states, thereby bypassing all lower courts. U.S. Const. Article III § 2.
9. New Hampshire v. Massachusetts, Docket No. 22O154, Brief In Opposition to Motion For Leave to File Complaint, 11 December 2020, p. 3.
10. In fact, their only remedy may be to the administrative tribunals and courts of the state attempting to impose the tax. 28 U.S. Code § 1341.
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