State Tax Implications of WFH
Before You Make any Permanent Decisions Regarding Your Company’s WFH Policy, Better Consider These State Tax Compliance Costs
There is a lot of ambiguity around the tax implications of the work-from-home (WFH) model that was forced upon an overwhelming number of businesses in the US since last March. Even congress still does not have all the answers to many of the corporate and business tax discrepancies arising due to the epidemic, and a lot is still unknown.
However, there is one thing we do know for sure
To this day, there is no national standard for a number of tax issues arising from this national health emergency, and companies operating in the US need to urgently model out the implications of their WFH policies to avoid paying double tax along with other increased compliance costs in their next reporting.
And as nearly two-thirds of companies considering to render their WFH policies permanent and a staggering 42 percent of the U.S. labor force already working from home full-time, the first step for decision makers in companies operating in the U.S. is to take a good long look at some of the tax consequences of remote work, before making any permanent decisions regarding their WFH policies.
First, let’s take a look at some of the macroeconomic numbers
- S. gross domestic product fell at a 32.9% annualized rate, the deepest decline since records began back in 1947.
- S. retail sales reached a historic slump, the highest drop since 2008, plunging an unprecedented 14.7 percent in April. (Though now showing signs of returning to pre-pandemic levels)
- Nonfarm payrolls decreased by 20 million jobs in April (though showing slight improvement over last few months)
Clearly, an economic disruption of this magnitude takes its toll on businesses, and the attraction of saving costs on property tax to increase business’s liquidity has perhaps never been stronger. Add to that the health risk of having packed offices, and it’s clear why a growing number of companies, led by some of the strongest ones in the market such as Twitter, Shopify, Upwork, and others, prefer adopting the WFH model permanently.
However attractive, this approach should be adopted with great care, to avoid increased compliance costs in numerous states once your company’s employees are living in one state and working in another.
But before drilling down to tax complexities, it’s worth indicating how remote employees (or telecommuting employees) are viewed by U.S. regulation, since it has bearing on wage reporting and withholding, tax nexus, apportionment, state and local payroll tax, and more.
When does the definition “Work From Home” apply?
Your company’s employees may be working away from the office, but here are some of the potential scenarios relevant from a regulatory perspective, according to KPMG:
- Individual displaced from regular place of business due to closure
- Working from their resident state as detailed in corporate records, with no reciprocity with the regular work state
- Working from a state that has a reciprocal agreement with the regular work state
- Working from another location in a different state
- Working from a state with no state income tax, but primary work state has an income tax
This is where it gets complicated
Different taxes are based on various jurisdiction factors (such as where services are performed, where payroll is submitted, where sales take place, etc.). For example, originally, the income tax nexus is based on the state’s jurisdiction over the business, considering where its employees physically perform their duties, which up to Covid-19, has been mostly at the office. However, now that employees are working remotely from their respective states, the business might technically be required to file income tax returns in multiple states.
Some states have addressed this matter and initiated guidelines on whether having a telecommuting employee creates corporate income tax nexus, even before COVID-19 has come into play, such as New Jersey, Idaho, and California. However, none of these rulings was created for circumstances of remote work due to a global health emergency.
So, what should businesses operating in the US consider, before making any permanent WFH policies?
Here are some of the main factors that should come into play when considering a WFH policy
According to KPMG’s webcast on State Tax Implications of a Remote Workforce, there are a few main tax considerations of WFH:
There are a few first steps to modeling out the nexus implications of remote work, while taking into account both general state nexus rules and state-specific COVID-19 guidance and nexus relief:
- Physical presence nexus: companies need to analyze the physical presence of their employees to understand which states have jurisdiction to impose corporate income and franchise taxes
- De minimis nexus: if your company’s sales, property, or payroll in the state exceed a certain threshold, in many states that would be considered an economic nexus (according to the Multistate Tax Commission proposal, $50,000 of payroll or 25% of a company’s total payroll in a tax period would meet the de minimis requirement).
- Public Law 86-272: consider whether the activities of temporarily remote employees exceed the scope of P.L. 86-272, in order to avoid paying income tax in numerous states
- Nexus relief during state of emergency period: some states (15 states plus the District of Columbia) have released guidance saying that remote employees due to COVID-19 in their jurisdiction will not trigger filing responsibility. However, who is to determine when this nexus relief is over? Is it when the pandemic will have officially diminished? Or when the official state of emergency period be over?
- Documentation: in order to prove that nexus was not established due to remote employees being a temporary situation as a result of Covid-19, companies are required to provide careful documentation to support this claim
Will moving to a remote work policy affect a company’s sales, payroll, and property factors?
- Apportionment: having remote employees may affect apportionment if the state has a cost of performance rule for sourcing receipts from sales of services or a rule that looks to where services are performed
- Payroll: generally determined by employee location, an employee’s payroll will be attributed entirely to one state, while in many cases, taxpayers attribute payroll based on where an employee’s compensation is reported for state unemployment insurance purposes
- Property: the property factor will also be affected when remote employees use company owned equipment in their remote locations
Local tax liability may also come into effect depending on whether:
- Gross receipts are based on where services are performed
- Gross receipts are based on the average of payroll and sales
- Business income is based on the average of property, payroll, and gross income in the respective city
State and local payroll tax
State/local income tax withholding considerations include:
- Withholding and reporting should be in the state where services are performed
- Withholding location should be based on information self-reported by employees as well as HR info
- Locality taxation may follow either work or residence location (locality dependent)
- Income should be sourced to the state where employee performs services, whether regular work state or elsewhere
- Taxation may also be required in an employee’s resident state
- Nonresident employees traveling to different states should generally have SIT withheld in those states (where applicable)
- Certain exceptions apply:
- De minimis requirements for nonresident travel – generally would not apply to COVID-19 reporting issues
- Reciprocity between states/locals
Be that as it may, there are reciprocal agreements meant to simplify reporting processes for both employers and employees. These often allow for residents of one state to request exemption from tax withholding in the other (reciprocal) state, which is typically common among adjacent states or those that have a significant number of commuters.
Leaders should follow these crucial steps
To make the most informed decisions, leaders in companies operating in the US in such turbulent times should follow these crucial steps:
- Evaluate how broad your current employment footprint is (taking into account withholding accounts in multiple jurisdictions, the reciprocity impact, and local withholding requirements)
- Check if the states you are operating in issued specific guidance
- Review your risk-tolerance for those states you operate in that have not issued guidance
- Consider if WFH extends longer than you had initially expected
If your company decides to fully adopt a WFH policy for its many health and liquidity benefits, and stop paying (sometimes so much as 15%) of its overall profits to real estate rental, it’s important to consider that going for a 100% virtual policy will render the company not entitled for relief, given it now has nexus everywhere it has employees. The results might be increased compliance costs and having to file tax returns in all those states.