Oh, how the world has changed in just a few weeks! Stay-at-home orders prompted by COVID-19 have forced a sudden and massive relocation of the U.S. workforce from company offices to employee living rooms. But when one of those living rooms is located in a state where the business is not otherwise subject to income tax, the company must consider whether this change in working arrangements creates nexus within that state and triggers a state income tax filing obligation.
For those employees who live in one state but work in another, employers may find themselves, for the first time, having employees performing a significant amount of work in a new state.
Nexus is a connection between a taxing jurisdiction, such as a state, and an entity. When a business has nexus with a state or city, it’s typically required to register with the tax authority and pay the applicable corporate, employment, excise, and sales taxes.
When an employer that is based in State A allows (or requires) an employee to work remotely from State B, whether regularly or temporarily, the employer must evaluate how this new arrangement affects its tax responsibilities.
In the wake of COVID-19, is the employer now required to withhold State B employment taxes from the employee’s wages? Does the presence of the employee in State B create income tax filing and payment requirements in State B? How does the presence of the employee in State B (and potentially property used by the employee in State B) affect the employer’s income tax apportionment?
It does seem that the presence of even a single employee in State B almost certainly allows that state to impose income tax on the employer, require the employer to collect State B sales tax, and withhold employment taxes.
What could make this even more interesting, post-COVID-19, is that states and localities that are already starved for cash will undoubtedly be looking for new sources of revenue. While constitutional issues could be implicated, there is the potential for nexus “whipsaws.” For example, if —in the above example—State A takes the position that remote working due to the pandemic should be ignored but State B takes the position that the presence of the employee in State B creates a nexus, the employer could face two states trying to tax the same income.
Many businesses now find themselves in this situation without any opportunity to preplan or evaluate various state laws. In the absence of guidance from states, tax departments will need to assess whether and how they are required to file returns in several state and local jurisdictions in which they have not previously filed.
States could assert nexus over companies that find themselves with a new in-state physical presence (due to employees working from home.) However, many states and localities have issued guidance indicating that, in the context of the current crisis, ordinary nexus rules will not be strictly enforced. Specifically, as of April 15, 2020, Pennsylvania, New Jersey, the District of Columbia, Indiana, and Mississippi all announced that employees working remotely in those jurisdictions due to COVID-19 would not create nexus for their employers. Other taxing authorities likely will announce nexus-related policies in the upcoming days and weeks.
States aren’t unsympathetic to situations brought on by the pandemic. Most have indicated a willingness to work with companies and individuals having a hard time fulfilling their tax obligations because of declining business or lost work caused by COVID-19. Yet that goodwill is unlikely to last forever. The hard truth is that states rely on tax revenue to keep the lights on and pay for essential services. The longer the pandemic lasts, and the greater its impact, the more money will be needed for assistance programs. Even states taking a lenient stance toward temporary remote employees could reevaluate those policies, especially if a “temporary” situation stretches to months.
The crisis has called attention to an issue that existed before the pandemic and that will continue to exist. In ordinary times, businesses should be careful when allowing employees to work remotely in other taxing jurisdictions. They should pay attention, not just to employment-related concerns, but also to potentially unexpected tax consequences.
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