The work-from-home tax crisis we have to see coming
The living room is the new conference room, and it could lead us down a sticky path when it comes to taxes. As COVID-19 upended the world this past spring, 98 percent of businesses in the U.S. went to a work-from-home model, and some CEOs — like Barclays’ Jes Staley — predicted crowded corporate offices with thousands of employees “may be a thing of the past.”
But as business leaders and elected officials alike seek to find some footing on this uncharted terrain, they seem to encounter an unintended consequence of our “new normal” in almost every direction. For companies that have gone remote, one of those is the development of a large, work-from-home tax nexus.
Working in one municipality and living in another is nothing new. Telecommuting has been the way of the world at many large national and multinational companies for years. And for even longer, residents of area suburbs around the country have made the trek over bridges, across rivers and through tunnels to their nearby city in another state.
But just like the world wasn’t quite expecting to move tens of millions of people to online work stations at their kitchen table overnight this past March, some companies haven’t been able to get their arms around what their next tax season will look like with a large chunk of their workforce working in one state and living in another.
Right now, that admittedly seems fairly trivial. With debates ongoing about whether to re-open schools, how to handle a growing need for hospital resources, and enacting health and safety guidelines for those who have to return to offices, the idea of this new work-from-home nexus is probably low on the priority list in every C-suite. But as we’ve seen over the last few months, the situation about the future of the workplace is very fluid and the effects can have massive implications. Those advising businesses on their tax strategies need to be ready for this crunch.
Typically, tax nexus is based on where employees physically perform services (although other factors can come into play). For example, an employee at a New York City-based business will have income tax withheld for New York, and the business will also have income tax nexus in New York because its workers are physically housed in the city.
But if that same New York City business now has the majority of its employees performing their tasks at their homes in New Jersey, it now has an income tax nexus in the state of New Jersey, meaning it would technically need to file there as well. Fortunately, some states (including New Jersey) have announced that nexus won’t be asserted if employees are working from home solely due to COVID-19-related closures or social distancing policies. However, not all states have taken this position or provided specific guidance.
Managing this situation can get really sticky in states that have similar income tax laws, but tax rates that are different. For example, California has a much higher tax rate than its closest neighbors; the same can be said for Illinois.
As we inch closer to the fall, and states start to operate with the specter of any further shutdowns looming overhead, along with the very real possibility of many of their workers becoming permanent telecommuters, business accounting could get much more complicated. On top of that, some states will undoubtedly suffer a bigger shortfall in their tax coffers.
Proceeding with caution
While the world may not have been expecting this spring’s mass exodus for our respective home offices, getting ahead of this issue with the benefit of some foresight is a must. We can never again use the excuse that we just didn’t anticipate this kind of action. Unfortunately, some businesses will be able to adapt more easily than others.
While large firms will have more employees to consider, they have the resources to throw behind a comprehensive study to fully understand their state-level tax exposures. But some smaller companies may not want to — or simply cannot afford to — pay for a full nexus study to identify where they should file.
If a company is currently deciding whether to change its work-from-home policy, senior leaders need to look into tax consequences before they make a permanent decision. The financial effects can be significant. For example, if a company has nexus in a certain state and doesn’t file income tax returns in that state, the state can go after that company indefinitely with no statute of limitations. Why? Because the statute of limitations is generally based on the date a company filed. That combination of virtually unlimited look-back and the potential for reduced tax revenue in certain business-heavy states could create a recipe for future tax headaches for businesses for many years to come.
Ultimately, there is no way around this without hyper vigilance. Accounting firms are going to have to delve deeply into the intricacies of each of their client’s businesses because those that don’t know all the states their clients operate in, how many employees work in different jurisdictions, and other important details, are doomed to see severe complications next reporting season. On top of everything we’ve already endured, this is one headache that — if we’re proactive — we can avoid.