Tax Surprises with Work-from-Home Policies
- Remote working is here to stay, so businesses should be aware of cross-border state and local tax issues.
- Income and unemployment tax withholding can be complex if an employee lives in a state other than where the company is located.
- Tax interest and penalties can be imposed if a business fails to identify nexus obligations.
- Telecommuter rules create additional responsibilities for employers and employees.
Need help understanding remote workforce tax rules?
As businesses begin the post-pandemic transition, determining where their employees will work is a major consideration. On one hand, businesses are eager to get back to business as usual, but many organizations have determined that remote working — either on a hybrid or complete basis — has enhanced productivity and employee morale.
As employers and employees negotiate and codify their new work-from-home policies, they need to recognize that cross-border state and local tax issues may lead to tax surprises for both sides.
The two-state problem
Take, as an illustration, a company that has an office in Rhode Island, where everyone worked onsite pre-pandemic but can now work from home on part-time bases. Previously, this employer would have only needed to withhold Rhode Island income taxes for its employees. However, because some of its employees work partly from their homes in Massachusetts, the employer now has to register with the Massachusetts tax authority to withhold Massachusetts taxes as well.
Additionally, the state unemployment taxes the employer pays on its employees may also have to shift from Rhode Island to Massachusetts. Unlike income taxes that may be owed to the two states, unemployment taxes are generally paid to only one state. Which state obtains the unemployment tax is often based on a variety of factors; businesses will need to determine which state gets the unemployment tax for each employee.
Companies also need to consider whether having a remote employee creates nexus for the company in the state, requiring the filing of tax returns. For the company based in Rhode Island, having an employee working from Massachusetts creates a connection to Massachusetts, and as such the company would likely need to register and start collecting sales tax in Massachusetts.
Although a company may not be aware of this resulting requirement, if the company gets audited, the tax burden shifts to the business (rather than the consumer), and interest and penalties can be imposed on the business for failure to collect the tax.
Besides a sales tax collection obligation, the remote employee may also create an income tax obligation imposed on the business and its owners. That is, this employee may not only create a Massachusetts sales tax collection obligation, but may now also cost the company or its owners of pass-through entities (such as S corporations and partnerships) additional income taxes that have to be paid to Massachusetts.
The telecommuter rule
In another situation, an employee who lives in Rhode Island but works at a company based in Massachusetts may be hit with additional taxes on wages under a “telecommuter rule.” While only a handful of states on the East Coast have a telecommuter rule on the books (e.g., New York, Connecticut, Pennsylvania, and Delaware), during the pandemic Massachusetts instituted a telecommuter rule through an emergency regulation, which provides that if an employee works from home in one state, but their employer’s location is in Massachusetts, then Massachusetts can still tax that employee as if they physically worked in Massachusetts.
Although Massachusetts’ telecommuter rule is temporary and set to expire in mid-September 2021, it’s already been extended multiple times and may be yet again. This issue creates responsibilities for both the employer (who needs to withhold the appropriate state taxes) and the employee (who needs to file income tax returns with the applicable states).
Don’t be surprised
Identify where your employees are working in order to proactively confront the payroll tax, sales tax, and income tax obligations that remote employees create. While some of these issues may be temporary, as more organizations (and more employees) consider work-from-home solutions, understanding the financial implications associated with such policies is key to help mitigate the risk of unfortunate surprises at tax time.
How we can help
CLA’s state and local tax professionals can help guide you through these shifting state tax rules by analyzing your compliance obligations and identifying other ways these issues could affect your company. We’re here to answer your questions and help you reduce tax risks associated with your remote workforce.