When the COVID-19 pandemic started, no one could have envisioned how long remote work would last, or that working remotely could become a permanent option for many employees. Many LMC clients have reached out to us for clarification on the withholding tax requirements for remote workers. They are struggling with how remote workers pay state and local taxes and what is the employer’s reporting responsibility. In general, there is a difference between employees who work remotely because of their employers’ necessity and those who do so for their own convenience. With hybrid work arrangements becoming a lasting feature of the new workplace, employers should be very deliberate when they communicate and execute policies relating to an employee’s work location.
‘Convenience of the employer’ rule
The core question is this: Which state does the employee pay income tax to: the state where he or she lives, or the state where his or her employer is located? In most states, a remote employee must pay taxes wherever he or she resides. However, some states follow a “convenience of the employer” rule that treats days worked at home as days worked at the employer’s location if the employee is working remotely for his or her own convenience and not the employer’s necessity.
Some states have reciprocal agreements stating that employees only have to pay tax in the state where they live, no matter whether they are doing so for necessity or convenience. Employees in this category will only have taxes withheld for one state.
If the employee lives and works in different states and those states do not have a reciprocal agreement, the employee will have to file two tax returns, one for each state. In addition, some cities and localities, such as New York City and Yonkers, have their own taxes, which means some taxpayers will have to pay taxes in three jurisdictions.
While taxpayers affected by these rules will not necessarily be double- or triple-taxed because they usually are eligible for tax credits, each state has its own tax rates, and that could affect the taxpayer’s total tax bill.
Filing as a nonresident
It is important to keep in mind that even states that do not collect personal income taxes usually require the taxpayer to file a return, and that taxpayers who live in one of those states must file nonresident tax returns in states from which they receive a W-2.
Remote workers can cause additional work and filings for employers, who must make sure they are compliant with payroll tax withholding rules for accurate payroll tax withholding and reporting. Business tax filings may also be affected, including filings regarding passthrough business income, unemployment insurance withholding, workers’ compensation, disability, sales tax and employment requirements.
Sales tax can be a particularly thorny issue since it takes only one employee working in a state to create an economic nexus in that state.
There are many rules to consider, including how long COVID-19 rule suspensions or modifications will be in force. In many instances, these rules have already expired.
To be sure to avoid any penalties, businesses need to be familiar with the tax law in their resident state and any other states in which they operate or where they may have employees working remotely. Your LMC professionals are always available to assist you in navigating this changing area of the tax law.