Allowing employees to work from home until the pandemic subsides is a pragmatic choice for businesses responding to the crisis, but this arrangement has also raised potential issues at the state level regarding tax nexus, business taxes, and payroll taxes.

The challenges are compounded by two factors. First, as pandemic-related remote work surges, multiple states are adjusting their regulatory positions on tax nexus and tax obligations. Some states have provided clear regulatory guidance for businesses, while others have not, leaving affected companies potentially facing a compliance vacuum. Second, businesses may not know where employees are actually working, which could lead to inadvertently missing necessary state filings. Pending legislation in Congress could alleviate these issues, but the prospects for the bill remain uncertain.

Is there tax nexus?

A business with tax nexus in a state is subject to that state's jurisdiction and must comply with its tax laws. Certain situations—such as having a corporate headquarters or sales office in a state—constitute physical nexus. In 2018, the Supreme Court's ruling in the Wayfair case allowed states to impose sales tax on remote businesses' in-state sales based on economic nexus.

Historically, states have generally held that if an employee works in a state, the employer is obligated to withhold that state's payroll taxes, but the impact of remote workers on an employer's tax nexus in that state has largely remained an open question, said Dan Kidney, state and local tax director at Wipfli LLP.

Kidney cited an example: an IT specialist working remotely whose duties are purely internal and unrelated to the production of the company's goods or services—such an employee would typically be unlikely to create tax nexus. But given that the pandemic has dramatically expanded remote work and strained state budgets, Kidney noted that more states are taking the position that the presence of such remote employees in the state creates tax nexus for the employer.

However, the tax nexus issue related to pandemic-driven remote work remains unclear. It depends on state regulations, and as of early August, some states had not yet issued clear guidance.

Hodgson Russ law firm surveyed all 50 states and released a report on August 10 titled "State-Level Pandemic-Related Guidance: Remote Work Issues Update." The firm asked: "Is tax nexus imposed due to remote work?" The good news is that a growing number of states responded that employees working remotely due to the pandemic would not create tax nexus for corporate income tax or sales tax, at least for a certain period. Other states responded that nexus would be created, typically because they had not modified their regulations in response to the pandemic. Troublingly, a significant number of states provided no guidance at all.

Tax nexus is critical. Kidney encountered a case where an employee's wife was transferred to Massachusetts, and the employee subsequently asked his employer to relocate him to that state—a move that would establish corporate income tax nexus for his company. The resulting business tax burden was so severe that the company ultimately declined the request and suggested he consider moving to a neighboring state or resigning.

Where does personal income tax belong?

States have the authority to tax the worldwide income of their residents. The typical arrangement is that a taxpayer working outside their resident state pays personal income tax and files in the nonresident state (i.e., where the employer is located), then claims a corresponding tax credit on their resident state's return (if that state imposes an income tax). For state tax purposes, an employee's income tax liability is generally based on where they actually perform the work.

Eileen Sherr, senior manager of tax policy and advocacy at the American Institute of CPAs, said some states and jurisdictions (such as the District of Columbia, Maryland, and Virginia) have reciprocity agreements that eliminate the need for nonresident state withholding and cross-state filing.

Sherr noted that there is currently no uniform national standard for determining when a state may begin imposing payroll taxes. "If you enter another state for just a few days, each state has its own rules on how long you must work there before income tax applies," she said. "Some states tax from day one, while others allow more than 60 days of work without triggering tax liability."

Additionally, several states use "convenience of the employer" rules to decide whether to tax remote employees. These regulations allow the employer's state to tax the full compensation of remote employees unless the employee is working remotely for the employer's convenience rather than the employee's own convenience.

Inability to access the office due to the pandemic would seem to clearly fall under the employer's convenience, but guidance from relevant states ranges from explicit to nonexistent.

The Hodgson Russ survey asked: which state should tax the income of remote employees? Some states responded that it should be the employer's state, others said the employee's state of residence, and some did not respond. As a result, some employers and employees may face two states simultaneously claiming taxing rights, creating a risk of double taxation.

Beyond tax nexus and payroll taxes, Kidney noted that pandemic-related remote work also raises other areas to monitor, such as workers' compensation and unemployment insurance laws in the states where remote employees are located. "These issues also involve various non-tax matters, such as minimum wage laws in the state where work is performed, and whether the employer is considered to be doing business in that state (for secretary of state registration purposes) because it has remote employees there."

Tracking employee work locations

It is natural to assume that employees are working from their primary residences during the pandemic, but that assumption carries high risk. News reports show that large numbers of urban residents have moved to parents' homes, vacation homes, or less populated areas.

Sherr emphasized that employers must know where their employees are working. "They should know where employees are working and try to track how many days they work there, when they started, and whether they have changed locations," she said. "They should check the states where employees are working to see if those states provide guidance and how long an employee must work there before taxes are owed."

Monitoring legislative developments

In July, the Remote and Mobile Worker Relief Act (S. 3995) was introduced in the Senate and subsequently incorporated into the Health, Economic Assistance, Liability Protection, and Schools Act (HEALS Act).

According to Ernst & Young, the HEALS Act would provide:

  • Prohibit states from imposing state income tax and withholding on employees working temporarily in a state for fewer than 90 days due to the pandemic, effective through December 31, 2020.
  • Exempt employees and employers from nonresident income tax and withholding obligations if an employee works in a nonresident state for fewer than 30 days in a calendar year. This provision would apply from 2021 through 2024.
  • Provide tax nexus relief from state business tax collection for employees temporarily working in a state due to the pandemic emergency.

As of mid-August, Jamie Yesnowitz, principal and national tax office leader for state and local tax at Grant Thornton LLP, expected no progress on the HEALS Act for several weeks, and it remains unclear whether the legislation will retain the mobile workforce provisions. Nevertheless, he advised CFOs to continue tracking the bill's progress and to monitor guidance issued by state tax authorities (typically in the form of notices).