May 20, 2020
State Tax Implications of Remote Employees Due to COVID-19
Posted by Peter Klinger
With the rapid adoption of city and county shelter-in-place rules and state lockdowns (i.e. Hawaii) many employees found themselves working from locations that they never expected to be working from and for much longer than expected. Now employers have begun to ask, “Where are my employees working from? And what do I need to consider as a result of having almost, if not all, my employees now be remote employees?”
Unfortunately, the answer isn’t easy or straightforward. Having employees working remotely can potentially impact the employer’s state income tax withholding and business activity taxes (e.g. income, franchise and gross receipts).
State Income Tax Withholding on Employee’s Wages
Generally, state income tax withholding is required in the state where the employee is providing services, NOT the state the employee resides. There are exceptions to this rule, for example, if there is a reciprocal agreement between the state of residence and the state where the work is performed. Reciprocal agreements, most commonly seen on the east coast, allow residents in a neighboring state to not have to file and pay income taxes on wages earned in the non-resident state. However, due to COVID-19, many employees are now working from their homes or maybe wherever they were when the shelter-in-place or lockdown rules were executed.
Having employees performing work in these new jurisdictions may require employers to register with the state and begin withholding payroll taxes on that employee’s wages.
But at what point is that required? After the employee has been there a week, two weeks, a month, two months, longer? Unfortunately, many states remain silent on the length of time that an employee must be working from that state to create a withholding requirement.
The good news though is that the states that have started addressing this question via guidance or law changes, have said that so long as the employee’s telework location is temporary and a result of the COVID-19 pandemic, the state will NOT seek to impose withholding requirements. However, employees that choose to continue working from their remote location after an applicable work from home order has been lifted could be subject to state tax withholding in that state/city.
Income Tax / Business Activity Taxes (BAT) Nexus
Income tax/BAT nexus can be established by physical presence and/or economic nexus. Numerous states have some sort of economic nexus rule or have set economic nexus thresholds, but regardless of whether or not a state has an economic nexus standard, the physical presence of an employee working within the state generally establishes income tax/BAT nexus. That being said, what happens now that employees are working from states that they have never worked from before? Does that employee’s inability to travel to their normal office location (which may be in another state) now create income tax/BAT nexus in the state or city that they are now working from?
Prior to COVID-19, states had taken a pretty hard line that having one employee in the state, even if for only one day, could subject that business to the state’s business tax (income/franchise/gross receipts). Some states had expanded physical presence to mean the employee had to be in the state/city in excess of seven days to create physical presence nexus, with other states defining it as 10 days. Now with COVID-19 shelter-in-place currently approaching 10 weeks in some areas, businesses must now consider what new jurisdictions they might have income tax/BAT nexus and whether they will need to file any additional 2020 state/locality tax returns due to the location(s) of their remote employee(s).
Similarly, some states recognized the implications of remote employees on business taxpayers and have provided COVID-19 nexus relief stating that the state’s tax department will not use someone’s temporary location as the basis for asserting BAT nexus in the state. Georgia even went so far as to say that an employee’s temporary location would not void Public Law 86-272 protection for that employer so long as that employee’s location is temporary and there remains an “official work from home order issued by an applicable federal, state, or local government unit.”
The fact that Georgia addressed P.L. 86-272 implications is much appreciated as most states have remained silent on this even if they have provided general COVID-19 nexus guidance. Re-evaluating P.L. 86-272 protection is something any business that has previously claimed protection should do, as having non-sales employees within a state is considered an unprotected activity and will void any P.L. 86-272 protection previously applicable to the business taxpayer. Consequently, it may cause business taxpayers to not only have additional state income tax liabilities but also impact the amount of sales subject to throwback to the state of origin (if goods are shipped from a state with a throwback rule).
The key to ensuring than an employee’s remote location does not create income tax/BAT nexus is to make sure the employee’s location is in fact temporary. If an employee chooses to remain in their remote location after an applicable work from home order has been lifted, the COVID-19 nexus relief may no longer be applicable. However, it is less clear if even a temporary remote location will void P.L. 86-272 protection, especially as states have more recently pushed against the application of P.L. 86-272 protection in general, as it limits their ability to tax out-of-state taxpayers.
Sales/Use Tax Nexus
Similar to BAT taxes, sales and use tax nexus has historically been created by having even just one employee visit the state, let alone reside there for multiple weeks. While the Wayfair case created economic nexus rules for most states and many localities, the state’s physical presence rules remain in place post Wayfair. Having employees temporarily reside within a state where the business is not already collecting and remitting sales/use tax may now subject that business to new sales/use tax registration, collection and filing requirements.
Most states that have considered the implications from COVID-19 remote employees to payroll tax withholding and BAT nexus have also recognized the need to address the impact on sales/use tax nexus. These few states have issued guidance that sales tax nexus will be “waived” so long as no other factor created sales/use tax nexus – meaning if the jurisdiction’s economic nexus thresholds are met, or if the taxpayer had property in the state in addition to the remote employee, then the state would not waive sales tax nexus.
What should employers do? The most important step is making sure you know where your employees are working from and then monitor their time in that location. Employers should also continue to monitor the guidance issued by states where they have employees currently located.
What should employees do? Employees should keep track of the time spent working at their temporary telework location, monitor payroll tax withholdings on their paystubs, and inform their employer if their current location is expected to continue once shelter-in-place/lockdown rules are lifted. Becoming more knowledgeable about their current location, state of residence, normal office location payroll withholding and personal income tax rules will help employees review their payroll tax withholdings and assist them as they consider any new state tax filings for 2020.
Ideally, the hope is that instead of waiting on all the states to each issue their own guidance on payroll withholding, BAT nexus, and sales/use tax nexus, there would be some level of federal guidance, as COVID-19 is a global pandemic that has implications for everyone in every state and is not a “natural disaster” limited to one or even a few states. However, it is unknown if that will happen and for now, we must rely on each jurisdiction’s approach to providing relief to taxpayers whose workforce may be unexpectedly more dispersed across the country or even the world due to COVID-19.
For the latest regulatory changes and other information on keeping your organization running through disruption, visit our COVID-19 Resource Center.
Peter has more than 25 years of experience in the compensation and benefits arena, with areas of focus including accounting, income tax and plan design. He consults with businesses on issues as varied as reviewing W-2 forms and fringe benefits to equity compensation and creating 401(k) plans.
Areas of expertise include 280G/Golden Parachutes, Nonqualified Deferred Compensation Plans, ASC 718, 162(M) Plan Design and Qualification, Section 83, Partnership Compensation, Employment Tax and Fringe Benefits.
Peter holds a bachelor’s degree from the University of Miami and received certification as an investment management analyst from the University of Pennsylvania, Wharton School of Business.
Co Authors :
Kaylyn is a Senior Manager in Armanino’s State and Local Tax practice and leads the firm’s state TCJA practice group. She has been with Armanino for over ten years and has primarily focused on the high technology industry for both private and public corporations in such areas as multi-state corporate income tax, ASC 740, FIN48, business activity tax (BAT) nexus analysis, local taxes such as San Francisco Gross Receipts Tax (SFGRT) and Los Angeles City Business Tax (LACBT), unitary and consolidated filings, and revenue sourcing analysis for apportionment purposes.
Kaylyn has been a key leader for internal state and local tax trainings and, previously, she has been a speaker at Armanino’s EVOLUTION Conference addressing state tax compliance during changing times.
Kaylyn received a Certificate of Advanced Accounting Proficiency (CAAP) from Santa Clara University’s Leavey School of Business and a bachelor’s degree in economics and business from Westmont College.
Kaylyn is a Registered Lobbyist with Los Angeles and an active member of Armanino’s Women’s Advancement Network.