By Alex Lewis
Working remotely has become the new normal, and it may stay that way after COVID-19.[1] Although many professionals enjoy the safety, freedom, and flexibility that comes with remote work, a potential tax nightmare may be around the corner for some in 2021. If employees did not switch over their withholding once they started working remotely in a different state, those individuals could incur a higher tax bill in their resident state and possibly incur penalties.[2] Additionally, companies that now have employees working in states other than the business’s home office may unintentionally trigger income or sales tax nexus in their employees’ home states.[3] These employers may also be required to pay unemployment insurance tax in those states that employees now call home.[4] Although some state legislatures have released guidance for determining nexus and apportionment of income due to remote workers, many states have yet to address the issue.[5] Out of all the uncertainty caused by COVID-19, one thing is clear—preparing and paying income, payroll, and unemployment tax for both individuals and corporations could be complicated and expensive.
Individual Income Tax Implications
Typically, the state in which a taxpayer resides taxes all of their income, regardless of where it is earned.[6] Additionally, when a taxpayer works in more than one state during a year, the individual must, in most states, allocate their income to the respective state in which it was earned.[7] When this happens, the taxpayer’s resident state will give a tax credit to the taxpayer for the state income taxes paid to another state.[8]
When employees began working remotely due to COVID-19, the taxpayer may now have less income to allocate to the state in which they normally worked (if it is located in another state).[9] Since less income will be allocated to the state in which they normally work, the amount of taxes due and the amount of credit that the taxpayer will be able to claim on their resident state income tax return will be lower.[10] The smaller credit could cause the taxpayer to have a much higher income tax liability in their resident state, which could result in tax penalties for failing to make estimated payments in their resident state.[11]
Although some states have exempted income earned in the state because of COVID-19,[12] others have not.[13] Thus, employees should check with their employer and change their withholding requirements to their resident state to ensure that they do not incur tax penalties as a result of working remotely.[14]
Business Income/Payroll/Unemployment Tax Implications
Businesses that allowed their employees to work remotely due to the COVID-19 pandemic may face far more challenges. There are a variety of ways that states require businesses to apportion income.[15] Most states require businesses only to apportion income based on the sales made within the state.[16] Those states will likely be unaffected by the COVID-19 remote workforce. However, other states apportion income with a multi-factor model, which allocates income based on sales, property, and payroll.[17]
The remote workforce will change these calculations because remote employees will change the amount of payroll allocated to each state. Some states have released guidance exempting income earned by employees in the state that were relocated due to COVID-19.[18] Under these exemptions, income earned by remote workers due to COVID-19 will not be included in the apportionment calculation.[19] Other states only allow an employer to exempt payroll from the apportionment calculation during periods when a government shelter-in-place mandate was in effect.[20] Thus, a business may need to determine the specific dates employees worked remotely and cross-check those dates with shelter-in-place mandate dates to calculate the payroll factor appropriately. In rare situations, a company may trigger nexus in a state, and an additional filing requirement, simply because they had a remote worker in the state, even though the business did not have any sales or property in the state.
States that do not have traditional corporate income tax regimes could cause further issues for companies. In extreme circumstances, companies may be required to register and pay certain income and other taxes.[21] For example, in Texas, a non-Texas entity does not have to pay their corporate franchise tax unless it (1) has over $500,000 of gross receipts from doing business in Texas; (2) obtains a use tax permit; or (3) has physical presence in the state.[22] Establishing physical presence includes having employees or representatives doing business in the state.[23] So, if a company normally does not have over $500,000 in gross receipts in Texas, but now has an employee working remotely in the state due to COVID-19, the entity must now pay Texas franchise tax. Washington’s business and occupation tax (“B&O”) has similar tax characteristics.[24] In Washington, a business must pay B&O tax if it (1) has physical presence nexus in Washington; (2) has more than $100,000 in combined gross receipts sourced to Washington; or (3) is organized or commercially domiciled in Washington. Thus, a remote worker could trigger nexus for a company even if they do not normally meet the $100,000 threshold.[25]
Finally, companies that now have employees working remotely could cause the employer to pay unemployment insurance tax in the state in which the employee relocated.[26] Some states require an employer to file with the state and begin paying unemployment insurance tax once an employer has one employee working in the state.[27] In some circumstances, an employee may be exempt from triggering unemployment insurance taxes.[28]
Conclusion
With so many changes happening for employers and workers, many taxpayers may not yet be worried about their next tax bill in 2021—but maybe they should be. Making sure that employers are withholding income to the correct state could alleviate future tax issues. Also, for businesses that are merely trying to stay afloat during the pandemic, the potential additional filing requirements will be an unwelcome surprise next year. Although some states have offered guidance on how to allocate payroll to the state, the nonuniformity in tax laws across states creates a hassle and could lead to a higher tax bill (or, at least, a higher tax preparation bill). States still have time to issue helpful guidance to employers regarding their payroll allocation. If corporations are lucky, some states may entirely waive the physical presence threshold that would otherwise trigger a filing requirement. Conversely, since most states are facing severe budget deficits, they may be less forgiving and will not waive any remote work performed by employees.[29] If more states follow Georgia’s guidance, employers will undoubtedly incur additional headaches trying to cross-check governmental shelter-in-place mandates with specific dates that employees worked remotely.[30] Nevertheless, with some employers now embracing remote work as a permanent solution, Americans may feel the pandemic’s tax effects for years come.[31]
[1] Why Remote Working Will Be the New Normal, Even After COVID-19, EY (Sept. 7, 2020), https://www.ey.com/en_be/covid-19/why-remote-working-will-be-the-new-normal-even-after-covid-19.
[2] Katherine Loughead, In Some States, 2020 Estimated Tax Payments Are Due Before 2019 Tax Returns, Tax Found. (May 22, 2020), https://taxfoundation.org/2020-quarterly-estimated-tax-payments-2019-tax-returns/.
[3] Daniel N. Kidney, State and Local Tax Implications of Remote Employees During the COVID-19 Pandemic, Wipfli (June 19, 2020), https://www.wipfli.com/insights/articles/tax-covid-19-remote-employee-nexus (stating that nexus is typically created by having “physical presence” in the state).
[4] Larry Brant, Having Employees Working Remotely May Become the New Norm—There May Be Tax and Other Traps Lurking Out There for Unwary Employers, Foster Garvey (May 26, 2020), https://www.foster.com/larry-s-tax-law/tax-traps-remote-employees-covid19.
[5] Coronavirus Tax Relief FAQs, Ga. Dep’t of Revenue, https://dor.georgia.gov/coronavirus-tax-relief-faqs (last visited Sept. 16, 2020).
[6] See Idaho Code § 63-3011; see also Credit for Taxes Paid to Another State, Va. Tax, https://www.tax.virginia.gov/credit-for-taxes-paid-to-another-state (last visited Sept. 16, 2020).
[7] See Mont. Admin. R. 42.15.110(3) (requiring an employee to only allocate income that is “sourced” to the respective state); see also Or. Dep’t of Revenue, Publication OR-17 Individual Income Tax Guide 47 (2019), https://www.oregon.gov/dor/forms/FormsPubs/publication-or-17_101-431_2019.pdf (requiring an employee to apportion income by taking the number of days worked in the respective state divided it by the total number of days worked everywhere in a year).
[8] Idaho Code § 63-3029(1).
[9] See Or. Dep’t of Revenue, supra note 7, at 47.
[10] Idaho Code § 63-3029(3)(a)(i).
[11] See Loughead, supra note 2 (stating that Delaware, Indiana, Montana, Nebraska, New Jersey, New York, Oklahoma, and Rhode Island require estimated state income tax payments).
[12] FAQ Articles, N.D. Tax, https://www.nd.gov/tax/faqs/articles/412-/ (last visited Sept. 16, 2020).
[13] Guidance for Individuals Temporarily Living and Working Remotely in Vermont, Vt. Dep’t of Taxes, https://tax.vermont.gov/coronavirus#temporarily (last visited Sept. 16, 2020).
[14] For example, assume an individual taxpayer normally lives in New York, but works in Massachusetts and has a taxable income of $100,000. In a normal year, the taxpayer will pay $5,050 (calculated using the 5.05 percent Massachusetts individual income tax rate) in tax to Massachusetts. Thus, the taxpayer will be able to claim a $5,050 credit for taxes paid to another state on their New York return, reducing the amount of taxes owed to New York. Now, assume that because of a stay-at-home order, the taxpayer works at home for 75 percent of the year, and only 25 percent of its income will be allocated to Massachusetts. Then, the taxpayer will only receive a $1,262.5 credit on their New York tax return, causing the taxpayer to underpay their taxes substantially unless a withholding change is made. If no change is made, the taxpayer may incur penalties. See 2019 Personal Income Tax Rates, Mass. Dep’t of Revenue, https://www.mass.gov/info-details/major-2019-tax-changes#2019-personal-income-tax-rates- (last visited Sept. 16, 2020) (providing Massachusetts state income tax rates); Who Must Make Estimated Tax Payments?, N.Y. State Dep’t of Tax’n & Fin. (Aug. 5, 2020), https://www.tax.ny.gov/pit/estimated_tax/who_must_make.htm.
[15] State Apportionment of Corporate Income, Fed’n of Tax Adm’rs (Feb. 2020), https://www.taxadmin.org/assets/docs/Research/Rates/apport.pdf.
[16] Id.
[17] Id.
[18] See Frequently Asked Questions About the Income Tax Changes Due to the COVID-19 National Emergency, Neb. Dep’t of Revenue, https://revenue.nebraska.gov/businesses/frequently-asked-questions-about-income-tax-changes-due-covid-19-national-emergency (last visited Sept. 16, 2020).
[19] See id.
[20] See Coronavirus, supra note 5.
[21] Texas: Franchise Tax, Economic Nexus Rule is Finalized, KPMG (Dec. 20, 2019), https://assets.kpmg/content/dam/kpmg/us/pdf/2019/12/19611.pdf
[22] 34 Tex. Admin. Code § 3.586(f).
[23] Id. § 3.586(d)(5).
[24] Out of State Business Reporting Thresholds and Nexus, Wash. State Dep’t of Revenue (Apr. 2020), https://dor.wa.gov/education/industry-guides/out-state-businesses#:~:text=1%2C%202020%2C%20a%20business%20must,sourced%20or%20attributed%20to%20Washington (last visited Sept. 16, 2020).
[25] Wash. Admin. Code § 458-20-193(102)(a)(ii) (stating that even the “slightest presence” of a single employee may trigger the physical presence nexus).
[26] Stephen Miller, Out-of-State Remote Work Creates Tax Headaches for Employers, SHRM (June 16, 2020), https://www.shrm.org/resourcesandtools/hr-topics/compensation/pages/out-of-state-remote-work-creates-tax-headaches.aspx.
[27] Out-of-State Employers with Employees Living in Idaho, Idaho State & Fed. Res. for Bus. (July 30, 2020), https://business.idaho.gov/out-of-state-employers-with-employees-living-in-idaho/.
[28] Occupations Exempted from Unemployment Insurance Coverage, Wash. State Emp. Sec. Dep’t https://esdorchardstorage.blob.core.windows.net/esdwa/Default/ESDWAGOV/employer-Taxes/ESD-exempt-professions-chart.pdf (last visited Sept. 16, 2020).
[29] States Grappling with Hit to Tax Collections, Ctr. on Budget and Pol’y Priorities (Aug. 24, 2020), https://www.cbpp.org/sites/default/files/atoms/files/4-2-20sfp.pdf.
[30] See Coronavirus, supra note 5.
[31] Why Remote, supra note 1.
