07 Aug COVID-19, Telecommuting, and Taxes

With the onset of COVID-19, many employers were forced to conduct business in a different manner. Although, telecommuting is not new to the work environment, it became more prevalent when alternate work arrangements were needed to sustain business during the pandemic. Telecommuting allows an employee to work from home performing their normal job duties and it is being incorporated as a regular part of business operations for many employers.

Tax Nexus

Tax withholding for employees who telecommuted was a bit challenging for employers prior to COVID-19. Each state maintained their own guidance pertaining to telecommuters creating a tax nexus for their employers based on where the work was being performed. A tax nexus is a connection or relationship between a taxing authority (e.g., state) and a business. Generally, it references the interactions an out-of-state company must establish before it becomes subject to the tax laws and jurisdiction of a state. Overall, a tax nexus can be created by an employee’s physical presence, factor presence (percentage or amount of payroll, property, and sales), or economic presence (frequency or value of transactions in a state). The pandemic increased existing issues and in some instances, added additional complications.

There were some employees who relocated temporarily and/or moved to a different state without the employer’s consent. No harm, no foul…right? Unfortunately, it is not that simple when tax withholdings are involved. The million dollar question of the day becomes: Should an employee pay taxes in the state they live or in the state they work? The obvious answer would be to withhold taxes for the state the work is being performed in, which is fine for employees who live and work in the same state. But if an employee works in multiple states or telecommutes, it becomes a bit more challenging. Employers have to review guidance and tax regulations issued by cities and states to ensure they are in compliance.

For an example, if an employee relocated to a different state, potentially a tax nexus can be created, even without the employer having a presence there. Let’s say an employee worked in Florida but relocated to Georgia during the pandemic and continued to perform their normal job duties. Although, Florida does not impose a state income tax for employees, it may be imposed in Georgia causing a potential tax nexus to be created. In some states, the guidance governing a tax nexus was not waived and taxes continued to be withheld based on one of the presence factors. However, there were other states that issued guidance stating a tax nexus could not be established while COVID-19 related public health orders were in effect. With guidance varying from state to state, the tax withholding process was not simplified for employers.

Reciprocity

Tax reciprocity is an agreement between states, that allow employees to pay taxes where they live instead of where they work. The agreements eliminate the need for employees to file multiple state tax returns and it prevents double taxation from occurring. In the event, an employee is taxed for both states, a nonresident state tax form has to be filed to receive a refund. The states listed below have reciprocity tax agreements in place.

• Arizona – California, Indiana, Oregon, Virginia
• District of Columbia – All nonresidents who work in DC can claim exemption from withholding the DC income tax.
• Illinois – Iowa, Kentucky, Michigan, Wisconsin
• Indiana – Kentucky, Michigan, Ohio, Pennsylvania, Wisconsin
• Iowa – Illinois
• Kentucky – Illinois, Indiana, Michigan, Ohio, Virginia, West Virginia, Wisconsin
• Maryland – District of Columbia, Pennsylvania, Virginia, West Virginia
• Michigan – Illinois, Indiana, Kentucky, Minnesota, Ohio, Wisconsin
• Minnesota – Michigan, North Dakota
• Montana – North Dakota
• New Jersey – Pennsylvania
• North Dakota – Minnesota, Montana
• Ohio – Indiana, Kentucky, Michigan, Pennsylvania, West Virginia
• Pennsylvania – Indiana, Maryland, New Jersey, Ohio, Virginia, West Virginia
• Virginia – District of Columbia, Kentucky, Maryland, Pennsylvania, West Virginia
• West Virginia – Kentucky, Maryland, Ohio, Pennsylvania, Virginia
• Wisconsin – Illinois, Indiana, Kentucky, Michigan

Wrap Up

All in all employers are tasked with monitoring the work locations for their employees who are telecommuting to ensure they are withholding taxes for the correct state. When an employer’s payroll system is not configured for multiple state taxation, the employee is responsible for paying the taxes directly to the state, if they are working in a state that does not have a reciprocity agreement in place. There are other payroll concerns that may arise relating to disability, unemployment insurance, and worker’s compensation. In addition, employers may experience challenges with business tax filings due to not having a physical presence or nexus connection in a state. It is imperative for employers to perform their due diligence to ensure they are in compliance with the tax withholding requirements for each state. Also, it may be helpful to educate employees of the potential consequences that can arise from telecommuting in a different state.