With US Tax Day postponed until May 17, now may be a good time to talk to your clients about how the pandemic-enforced work-from-home (WFH) arrangements will affect their tax liability.
The income tax system across the United States is a bit of a patchwork quilt. Of course, federal income tax applies across the country. However, each country in the union is a separate sovereign state with its own taxing powers.
Not all states charge an income tax, but those that do have their own unique systems for doing so. In addition to state income taxes, many municipalities also have the power to levy income tax.
With so many taxing authorities, it’s no wonder people spend so much time and money trying to determine their correct tax liability and to which state they owe that tax. With many business offices closed as a result of the COVID-19 pandemic, many workers – our clients included – have been forced to work from home and their homes are often located in a different state or municipality than their now closed offices.
Moving workers and the work they produce—from the office to the home—has challenged various tax systems as states and municipalities try to increase revenue and employers and employees try to determine who has the power to tax the income earned from that work now that workers no longer actually commute to the office.
Below we provide some discussion points that advisors may consider raising with affected clients as 17 May approaches. Of course, the myriad local income tax rules dictate that you encourage your clients to seek advice from a knowledgeable local tax advisor who, if not yourself, can help you and your clients with these issues.
At its simplest, the question that arises from our unique federal system is whether a state may tax the income of a worker who works for and provides employment to a company in that state, but never sets foot on it physically. Of course, this same question can arise within a country that allows its municipalities to levy income tax. That is, can a town or city tax the income of a worker who works for a company in that town or city and provides work for it, but does not actually set foot in that town or city?
It is fairly obvious that a state can tax a worker who lives outside that state but comes into the state to work for an employer located in the state.1
Of course, governments run on tax revenue, and even before the current pandemic, many states attempted to tax the income non-residents working for in-state employers earned from their out-of-state homes. New York State is a prime example. Imagine a client who works for a company in Manhattan, lives in Connecticut, works part-time in an office in New York and part-time from home in Connecticut. New York law taxes non-resident employees, as do other states, based only on a portion of a non-New York resident’s workdays.2
However, New York considers an employee’s workday to be an out-of-state day for tax purposes only if the non-resident is obligated in the employer’s service to work remotely “when necessary, as different from convenience.”3 Thus, if our client in New York chooses to work from home instead of employer necessity, New York will tax all of that client’s income, even though they were working in Connecticut.4
The COVID-19 pandemic has brought this tax authority matter into greater focus as offices have closed and WFH arrangements have sprung up. For example, the state of Pennsylvania has issued guidance for Pennsylvania employers whose employees are working remotely due to the COVID-19 pandemic. As stated in the directive:5
In short, if an employee is working from home temporarily due to the COVID-19 pandemic, the department does not consider this to be a change in employee compensation sources. For nonresidents who were employed in Pennsylvania before the pandemic, their compensation will remain a Pennsylvania source of income for all tax purposes, including PA-40 reporting, employer detention, and three-factor business income distribution purposes for S corporations, partnerships, and individuals. . . .
“For an employer in Pennsylvania with a non-resident employee temporarily working from home due to the COVID-19 pandemic in a state that does not have a reciprocity agreement with Pennsylvania, the Department is advising that employee compensation continues to come from the State of Pennsylvania, and is asking the employer to withhold compensation.”
Massachusetts has taken a similar stance with regard to its taxpayers. According to Massachusetts Emergency Regulation 830 CMR 62.5A.3:
“…for the duration of the Massachusetts COVID-19 emergency, all compensation received for personal services performed by a non-resident who, immediately prior to the Massachusetts COVID-19 emergency, was an employee engaged in the performance of such services in Massachusetts and who, during such emergency, performs such services from a location outside of Massachusetts on account of Massachusetts sole personal income. Tax under MGL c. 62 and personal income tax “.6
Many of the workers employed by companies in Massachusetts live in neighboring states, including New Hampshire. New Hampshire does not charge income tax on salaries and wages and has asked permission to sue Massachusetts in the US Supreme Court7 To prevent Massachusetts from taxing the income of New Hampshire residents who work from home for Massachusetts employers.8 Massachusetts has described its action as simply maintaining the status quo regarding the management of its tax system during the COVID-19 emergency.9
With tax filing day fast approaching, what should a client employee who must pay income tax or a client employer who must withhold tax do?
For the customer business owner who must withhold the tax
If you lack experience, encourage them to seek the advice of a local tax professional familiar with the rules of the jurisdictions in which they operate to determine their obligation to withhold income and pay income tax in respect of their employees’ wages.
For the customer who must submit a tax return
Again, if you don’t have the necessary knowledge, advise them to consult a local tax professional who can help them decide how much tax they should pay and to which jurisdictions. If the state in which they work and the state in which they live do not have an agreement regarding the imposition of income tax, they may want to pay tax to the state in which they work, even though they were not actually working in that state, and then, file a claim for a refund.10
While this approach may be more costly, it may be similar to what it would have done in a normal pre-COVID-19 year. Also, by paying the tax and claiming a refund, they may avoid charging interest and penalties for underpayment of income tax. A skilled tax professional can help guide you and your clients in making these decisions.
If life doesn’t get complicated enough as we navigate the new world forced upon us by the COVID-19 pandemic, many of our clients must now unravel state and local tax uncertainties as they are forced to work from home. As with any complex problem, if you don’t have the experience, you have to dig it up. Help your clients find a tax and legal professional who can help make the right decision for themselves, their families and their wealth.
1. Due Process Clause of the United States Constitution, US Constitution. modify. XIV §1, allows a state to tax non-residents who work in that state (but, generally, not outside the state). The state “in general may tax only income earned within the state.” [state]“, and not income earned by non-residents outside the borders of the tax state. Okla. Tax Comm’n v. Chickasaw Nation, 515 USD 450, 463 N. 11 (1995); Shaffer v. Carter252 U.S. 37, 57 (1920) (“With respect to non-residents, jurisdiction extends only to their property owned within the State and to their business, trade, or occupation carried on therein, and the tax is only on income derived from those sources”); Travis v. Yale & Towne Mfg. Co.252 U.S. 60, 75 (1920) (a state has “…the jurisdiction to levy a tax of this kind on the incomes of non-residents arising from any business, trade, occupation, or occupation conducted within its borders,…”).
2. 20 NYCRR § 132.18(a).
4. A suit like this was actually filed in New York. Zelensky v. Court of Tax Appeals1 NY 3d 85 (2003), cert. to reject541 US 1009 (2004). In this case, the taxpayer split his time between his office in New York and his home in Connecticut. Perhaps unsurprisingly, New York’s highest court found that the taxpayer was working from home for her convenience, not the employer’s necessity, and levied her income tax on the taxpayer’s entire income. The US Supreme Court refused to hear the case. Other states also follow this path, such as Pennsylvania, 61 Pa. Code § 109.8, Nebraska, 316 Neb. Admin. Code §22-003.01C(1) and Delaware, Del. Code Regs. 31-200-800 Director’s Rule 71-13.3(b).
5. Remote Work During the COVID-19 Pandemic, Pennsylvania Department of Revenue (last accessed February 13, 2021).
6. TIR 20-5: Tax Implications for a Massachusetts Employee Working Remotely Due to the COVID-19 Pandemic, Massachusetts Department of Revenue, April 21, 2020 (last accessed February 13, 2021).
7. New Hampshire vs. MassachusettsDocket No. 22O154, Request for Permission to File a Complaint Invoice (last entry Feb 13, 2021).
8. New Hampshire seeks to invoke the original jurisdiction of the US Supreme Court in interstate disputes, thereby bypassing all lower courts. United States of America Article III § 2.
9. New Hampshire vs. Massachusetts, Docket No. 22O154, Brief Objection to Request for Leave to File a Complaint, 11 December 2020, p. 3.
10. In fact, the only remedy may be before the administrative courts and the courts of the state trying to impose the tax. 28 US Code § 1341.
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