Taxpayers who moved to another state during the pandemic to work remotely have been dealing with a more complicated tax season than usual, and it’s not so easy for the companies where they work, either.
The pandemic prompted many people to relocate to larger homes and across states, and accounting firms have been trying to help clients sort through all the complex multistate tax issues that created, both on the individual and business tax side, so they don’t run afoul of the tax authorities and states desperate for extra tax revenue. While many states offered tax relief in the first year of the pandemic, they weren’t necessarily so forgiving in 2021.
“We have quite a number of taxpayers that have discovered there are special rules for people who are telecommuting or working remotely that is different from the state in which they normally work,” said Robbin Caruso, partner and co-lead of Top 100 Firm Prager Metis' national tax controversy practice, in Cranbury, New Jersey. “We frequently have a client that lives, for instance, in New Jersey and is working in New York. They’re taxed by New York, and they get a credit for the tax they’re paying to New York by New Jersey, and that’s what they’re accustomed to having. Now what we’re experiencing is because of the pandemic many people have relocated. They’re working from other states where they have secondary homes and vacation properties, and they’ve rented out homes and moved to other states. They’re finding themselves subject to dual tax for unearned income in some instances where they have spent more than 183 days and perhaps became a statutory resident of another state, or where they’re working in another state that says, ‘Your income is subject to tax in my state.’ And the other state says, ‘Your employer’s business office is located in this other state and you’re subject to tax here.’”
Work arrangements appear to have permanently changed at many companies as employees have continued to insist on working remotely. “What started as a short-term response at the beginning of the pandemic in 2020 really turned into something much longer term, and in some cases it might be permanent,” said David Sacarelos, a partner at Top 100 Firm Seiler LLP in Redwood City, California. “It works for a lot of people, both from the employer’s side and the employee’s side. We’ll see where all the dust settles after many of the work restrictions are lifted in 2022.”
The workforce has become more mobile and is often working across state lines in neighboring states. “We’re seeing a couple of different things,” said Penny Sweeting, a partner at Regional Leader Geffen Mesher in Portland, Oregon. “Portland is a border town of Oregon and Washington, and so what we see a lot is employees of our clients working for a company in Oregon, but they live in Washington. In addition, we are seeing a lot of our clients hiring all over the country now. Instead of the job market being limited to the metro area that we live in, now it's everywhere. You can hire somebody in New York or Florida to work for your company, wherever they are. We’re seeing that and getting questions like, ‘Our employee was in Arizona for three weeks taking care of their parents. What should we do about that?’ There’s increased mobility of the workforce.”
Employers and employees are facing more demands to keep track of the time spent at particular locations because of state nexus rules.
“There’s more pressure on the employer in managing where their employees are,” said Sweeting. “For example, we interviewed someone that we thought was in California. When they filled out their paperwork, they had a Nevada address and then it ended up that they were actually a resident of Illinois. Make sure that employers have the correct information as to where the employee is going to be working physically so they can register and withhold taxes in that particular state."
"Part of the challenge is there’s other requirements besides withholding in different states for professional organizations," she added. "If you’re an attorney working for a California law firm and you’re physically in Illinois, does the Illinois bar have requirements for that or not? Other kinds of questions, like workers comp in the different states, oftentimes get overlooked. We’re just thinking about withholding on the individual level, but there are other issues that the employer needs to think about when hiring remote employees.”
Employees need to keep track of the time they spend in multiple states. “Most states allow an individual to apportion their income to divide it between states if their employer did not,” said Sweeting. “If you worked part of the time in Oregon and part of the time in Washington, Washington doesn’t have an income tax, but Oregon does, so you can limit the tax that you pay and get a larger refund. If your employer withheld too much income, then you submit that with your tax return. There’s an opportunity if employees are actually tracking the number of days that they’re working in various states to get a refund and make sure they’re not overpaying tax. Both sides, the employer and employee, would benefit from keeping track.”
The situations for where employees are working can be complex in some instances. “You might have an employee who works in several states, and that happened before COVID,” said Sacarelos. “You might have someone that lives in another state and works in California. You might have an employee who lives in California and works in another state, and you might have an employee who lives in a different state than where the employer is located entirely. That would be the remote employees we’re seeing on a regular basis.”
States cracking down
States are beginning to crack down, after initially offering tax relief in 2020.
“There were various concerns at the beginning of the pandemic, and states responded differently,” said Sacarelos. “There were a number of states that tried to offer some leniency and exceptions — as long as you’re withholding the same way you were before, we’re fine. And some states were not so gracious. A case in point would be the Massachusetts case where they were pretty hard-nosed about where they were going to withhold. That was brought up to the Supreme Court and they decided not to hear it. It was also a temporary bill, so maybe that was the reason why they decided not to hear it.”
The Supreme Court declined last June to take up a case in which New Hampshire sued Massachusetts for continuing to tax New Hampshire residents who worked remotely from home, instead of in their pre-pandemic offices in Massachusetts.
“The fact of the matter is different states responded differently,” said Sacarelos. “Many other states have actually given employees stipends to leave New York, San Francisco and other cities. I think Louisiana and six or seven states have some kind of wooing — come work in our state remotely. Obviously they’re trying to get taxes from them. There is some complexity to it. Every client in a sense is different.”
Federal legislation, the Remote and Mobile Worker Relief Act, was introduced in Congress in 2020, and
In the meantime, more states are trying to claim income taxes from people who work across state lines. “I believe that most states due to financial issues and distress incurred during this pandemic have become more aggressive than they were prior to the event of COVID starting,” said Caruso of Prager Metis. “They’re examining and reviewing how people are reporting and filing their taxes, both individuals and businesses.”
Taxpayers will need to work with tax professionals to help them deal with complex cross-state tax issues that could subject them to stiff penalties and back taxes. “A taxpayer always has to carefully consider what states they have filing obligations in, be it an individual or a business, and make certain they’re timely filing accurate income tax returns, filing extensions timely, making estimated tax payments due timely in order to avoid significant and unnecessary penalties and interest that may not otherwise have been incurred had they filed appropriately,” said Caruso. “A real warning to taxpayers is that the statute of limitations is never running for a tax return or a form filing that was required and was not filed, so if you have not filed a tax return, the statute is open. Should another state come along and assert a claim against a taxpayer that they have a filing responsibility for a prior year, particularly if it goes back a number of years where you haven’t filed, you can actually find yourself in a position such that you would owe taxes, penalties and interest to the second state, and it will be too late to claim a refund from your resident state. You will have already paid and reported this income and paid tax on it to your resident state, but you can no longer get or obtain a tax refund if you’ve gone past the statute of your resident state for receiving a refund. I’ve seen that happen with significant dollars, into the millions.”
States are taking a harder look now that some of the pandemic relief has expired. “States look at where the services are located, where the worker is, where the base of operations is,” said Sacarelos. “They look at where the employer is directing and controlling the work. They’re looking at where the residency of the employee is. There are many factors you have to put into consideration, and most of these considerations are similar from state to state. If an employer has a question about that and is not sure, there is an Interstate Reciprocal Coverage Arrangement, which is a national organization that works with all the states. They can request written approval to report all wages paid to a multistate employee in which the services are performed or where the employee lives, or where the employer maintains the business. They can request guidance and that’s helpful, but it’s still a lot of work.”
Closer scrutiny
States are more closely scrutinizing whether taxpayers have, in fact, relocated. “Residency is a little bit of a subjective term in the tax world, and states are starting to get a little bit more strict on creating residency,” said Sweeting. “In the state of Oregon, there have been some new local taxes, so high-income individuals and business owners have been trying to reestablish nexus elsewhere. It’s important to not only get a new driver’s license, change your address and register to vote. Those are the main things historically that people have done. But the states want to know that you don’t have the intent to come back. Did you sell your house? Did you establish a church in your new location? Did you join the gym in your new residence? What does your Facebook page say? Besides the other standard things that we think about in terms of address and voting and the DMV, what about those other parts of your life? What does that say about your residency? States are getting clever about analyzing residency to make sure that if people are moving around and want to establish residency, that they’re taking a look at those other factors.”
States have reversed course on pandemic relief in some instances. “Employers need to be careful about states like New Jersey that have changed,” said Sweeting. “They reversed all of their COVID relief back in September of last year, so if there were employees that were working remotely in New Jersey, they weren’t creating nexus during COVID, but now all of a sudden they are. It’s important for an employer to make sure that if employees are creating nexus, to prepare for the consequences of other ramifications in those states. It could be income tax as well as payroll taxes.”
Regional differences may apply as well. “States are different,” said Sweeting. “Each one has unique rules. There are consistencies with regions, like the Northeastern states tend to have similar rules. The Western states tend to have similar rules. Southern states tend to be similar, but they’re not always the same.”
HR departments often have to ask employees who want to continue to work remotely out of state to fill out paperwork saying they are no longer in the state where the business is located. “That’s really to solidify things like where your residency is, where you’re going to be working, etc.,” said Sacarelos.
Tax preparers are hearing questions from clients about where they need to file their tax return if they have worked for a company that’s in a different state than where they currently live.
“Every state has different rules, so a taxpayer may need to file a tax return in both states — the state they worked in and the state they live in — unless they're not subject to an income tax obligation under the respective state,” said Caruso. "Generally, all of a person’s taxable income worldwide is reportable in their home state where they’ve established domicile. ... In many cases, the income will also be reportable in a state where the work was performed or where the employee is located, so a taxpayer can find themselves in a position where they have tax that is due to both states, and that could become a problem. Generally, when the tax relates to wages, there’s a tax credit that you could get from your primary residence state. There are de minimis rules that many states have, so if your income is under a certain dollar or time spent in the state threshold, if these thresholds are not met, you may not have a filing responsibility in the second state.”
The time spent out of state would have to go beyond simply visiting another state for a conference for a week or so. “Once a person spends significantly more time there, generally they’re going to be subject to tax in both states,” said Caruso. “There are some states that don’t have an individual income tax, such as Florida, Texas, Nevada, South Dakota, Tennessee, Washington and Wyoming. The rules can be quite complicated and vary significantly from state to state. I would highly recommend that any taxpayer that’s living and working and/or whose offices are located in a different state consult an experienced tax professional on these matters. There can be significant penalties for not filing and paying taxes in a state where they have an obligation.”
Tax credits
Tax credits add an extra wrinkle to the possible complexities. “Most states provide a tax credit to a resident taxpayer that has an obligation to pay tax on their income to another state, but this is generally providing that the income is also subject to tax in that resident state,” said Caruso. “The credit is usually limited to the amount of tax that your resident state would have assessed on that income. For instance, if you work in New York and their tax rate is higher than in Connecticut, Connecticut is going to give you a credit on tax up to the amount Connecticut would have assessed on that income, not the amount of tax you actually paid to New York.”
Some taxpayers will make errors in figuring the right amounts. “Another common error that I’ve seen is where a taxpayer will offset their resident tax liability with a resident tax credit for taxes paid to another state where that same income was not actually subject to the resident state income tax because every state taxes different income,” said Caruso. “An example of that would be a taxpayer who lives in New Jersey and perhaps works in New York. If during the pandemic they were furloughed or lost their job and collected unemployment, that unemployment will be sourced to New York. New York taxes unemployment, but New Jersey does not tax unemployment, so there would be no resident tax credit available in New Jersey for the tax paid to New York. What I have seen is where people file their tax return and they take a credit for the full amount they paid to the other state, in this case New York, and then New York will come back and audit or examine that return or propose an adjustment to the tax return because the credit was not appropriate.”
Convenience of employer
In some cases, states like New York have so-called “convenience of the employer” rules that need to be taken into consideration. “Simply stated, the convenience is that the employer actually has a business purpose such as being near a major customer or supplier that requires the taxpayer to be in that other state,” said Caruso. “In this case, the employee is not subject to tax in the state where the employer is located. If the employer is in New York and they have an employee working remotely in Nebraska, the employee working in Nebraska for the convenience of the employer would pay numerous taxes. In addition, if the employer has an office in the other state where the taxpayer is working, then they generally would not have to file in the employer’s tax home state, which is basically the location where the company’s headquarters are or where major decision-making functions are made.”
It’s important for an employee to understand how the convenience rules may affect them. “If the employee is working remotely for their own convenience because COVID happened and they decided to live or work from a different location than where they were normally working, then they will be subject to tax in the employer’s home state,” said Caruso. “If the taxpayer can establish that they’re working from this other location in another state for their employer’s purpose or from a bona fide office in their state, then they can avoid being taxed in the employer’s state. This is mostly relevant where the tax rates are substantially different. If your employer is located in a high-tax state and an employee is living in and working from a lower-tax state, this could become important to them. The bottom line is that a worker needs to be working remotely for the convenience of the employer and not the employee. There are things they could do to create this prospectively, going back retroactively. These are going to be determined by the states.”
“You really see that in the East Coast states of Massachusetts, Connecticut and New York,” said Sacarelos. “That's the big impetus behind the Massachusetts case. We don’t really invoke that concept that much in California. That’s because there are tacit agreements between states like Connecticut, New Jersey, New York and Massachusetts, where a lot of people find themselves working and living in different states. I’m not sure that’s necessarily a national trend, but if it does apply, then you would definitely need to look at that. Those rules are applied and thought differently about in each of those states.”
Many New York employees began working across state lines after the outbreak of the pandemic. “A lot of people that were working in New York and living in other states used to go into New York every day,” said Caruso. “The office buildings shut down, everybody went home and worked from home. New York is saying that they are remote workers subject to our tax because the income is sourced from New York. Unless the employer is reimbursing them for their office and they have a telephone and an address and meet the criteria that the states have set out to avoid these convenience-of-employer rules, you’re going to be paying tax in the higher-tax state possibly, or in the state that believes the tax is worth it to them. This can create dual tax issues that may arise where the income is sourced in, let’s say, State A and the taxpayer performed the work in State B, and State B deems the income to be taxable in State B, and you can have a problem there.”
Reciprocity agreements
State reciprocity issues may also come into play. “Lucky taxpayers may avoid tax filing requirements if the neighboring states where they’re living and working have a reciprocity agreement in place that would relieve the obligation to pay tax on wages or salaries earned in their non-resident state,” said Caruso. “For instance, New Jersey and Pennsylvania have such agreements for the earnings of employees. If I’m living in New Jersey and working in Pennsylvania, my company in Pennsylvania is going to have New Jersey withholding taken out from my pay to arrive at my net pay, and I won’t have to pay taxes in Pennsylvania and then request a credit from New Jersey. There are a number of neighboring states throughout the country who have reciprocity agreements.”
Unearned income may need careful attention as well. “Dual tax issues on unearned income, such as interest and dividends, can be avoided if a person is careful not to be deemed a statutory resident of another state,” said Caruso. “This would generally happen when the taxpayer is present in another state for either work or personal purposes for over 183 days. This varies by state. The rules aren’t set for what deems a person a statutory resident in a state with a tax-filing responsibility. This is true even where a taxpayer may intend to and remain a domicile resident of their primary state. If somebody lives in New Jersey and they go and stay in Connecticut for more than half of a year during COVID, they’re going to be a statutory resident of Connecticut and a domicile resident of New Jersey, and their unearned income is going to be subject to dual taxation. Usually you’ll get tax credits from your primary state for wage income. They’re not typically as problematic. The bottom line is it’s very important that taxpayers keep detailed records to substantiate their tax position and that they maintain records for the days of presence test to demonstrate that it was not met in a second or more state, and if they did meet the criteria, that they’re careful to file returns in both states so they don’t find themselves subject to penalties later.”
Reasonable cause
Some states are allowing employers to avoid penalties if they can show reasonable cause. “None of this is easy,” said Sacarelos. “It's messy. As much as anyone tries to comply, they won’t be 100% compliant. You’d be working all day long to figure out where one’s liability is. In California, we’ve seen some signs that employers that did their best and made reasonable attempts to follow the law and maybe got it wrong a little bit, some of the penalties are not assessed because of reasonable cause rules. The ones I’m seeing are things like you missed a payment that was due in March of 2020. If something happened in the middle of the pandemic, you’re probably going to have a good chance to rectify it and not create too much of a penalty. Now, 2022 is a completely different story. We’ll see where that goes.”
