Many employers now have employees who have shifted from working in the employer’s office to working remotely from home as a result of the COVID-19 pandemic. When the employer’s office is located in one state and the employee now works from home in a different state has state tax implications, including creating tax nexus between an employer and a state (which would subject the employer to the state’s income and sales tax regimes) and requiring an employer to withhold state income taxes from compensation paid to such employee.
The states’ responses to dealing with employees working remotely have not been uniform. Most states have not provided any guidance. Many states that have provided guidance have adopted the position that a change in working location due to the COVID-19 pandemic will be ignored, although some of these states have not addressed the issue for both tax nexus and employment tax withholding.
Most states consider a company to have nexus in the state for purposes of all state taxes imposed (e.g., income, sales, and employment) if the company has employees working in the state. Prior to the COVID-19 pandemic, many states asserted nexus over employers due to the presence of a single home-office employee in the state. As a result of the pandemic, employees of many companies have shifted from working at an office in one state to working at home in another state. For employees who live in one state but work in another, many employers, for the first time, have employees performing significant work in a new state. Although states could assert nexus over companies who now have an in-state physical presence there due to employees working from home due to the COVID-19 pandemic, many states, including California, have advised that they will not assert nexus over a company solely due to such a connection with the state. In some states, such as Massachusetts, New Jersey, Pennsylvania and South Carolina, the decision not to tax out of state companies that now have employees in their state working at home is limited to the length of the pandemic state of emergency or will expire on a certain date unless extended.
With regard to employment taxes and tax withholding obligations, an employee’s wages for the performance of personal services are governed by the state where the work is performed for purposes of state individual income tax and related payroll withholding purposes. For remote employees this generally means that payroll withholding is due to the state from which they work remotely, regardless of the location of the employer. However, certain states and cities impose the “convenience of the employer” test (i.e., Connecticut, Delaware, Nebraska, New York State, and Pennsylvania) under which the wages of remote workers are still sourced to the employer’s location unless the employee can demonstrate that the remote working arrangement was done for the employer’s necessity, rather than the employee’s convenience. No states with the “convenience of the employer” test have provided guidance regarding this issue with respect to the pandemic.
Some of the states that have provided guidance include:
California
The wages of employees who typically perform services in another state for an employer located outside of California will not be subject to Unemployment Insurance (“UI”) tax, Employment Training Tax (“ETT”), and Disability Insurance (“DI”) withholdings if those employees are temporarily performing services within California due to the COVID-19 pandemic. If a worker remains in California performing services after state or federal public health officials have ended stay-at-home orders and the worker could have resumed working at their normal work location outside California, the worker and the employer will be considered subject to California employment tax laws.
Illinois
Out-of-state employers must withhold employees’ Illinois income tax after the employee has worked at home in Illinois for at least 30 days.
Massachusetts
A resident employee who, immediately prior to the Massachusetts COVID-19 state of emergency was an employee engaged in performing services from a location outside of Massachusetts, and who began performing such services in Massachusetts due to a state’s COVID-19 state of emergency or other pandemic-related circumstance, will be eligible for a credit for taxes paid to that other state. In addition, the employer of such an employee is not obligated to withhold Massachusetts income tax for the employee to the extent that the employer is required to withhold income tax with respect to the employee in such other state.
New Jersey
New Jersey sourcing rules dictate that income is sourced based on where the service or employment is performed based on a day’s method of allocation. However, during the temporary period of the COVID‑19 pandemic, wage income will continue to be sourced as determined by the employer in accordance with the employer’s jurisdiction.
New York
Under current law, employee taxation and withholding depends on where the “primary office” of the employee is located. The “convenience-of-the-employer” rule provides that an employer operating in New York must withhold New York State income tax from wages paid to an employee whose primary work location is in New York State if (1) the employee spent at least one day during the year in New York; and (2) the employee is working from home outside New York for the employee’s own convenience. New York recently released guidance which does not view the COVID-19 pandemic as creating a situation that should alter current law. Thus, an employee whose principal office is in New York State but who is working outside of the state during the pandemic generally will remain subject to New York State income tax, and the employer should generally continue to withhold New York State tax from the employee’s compensation.
Pennsylvania
If an employee is working from home temporarily due to the COVID-19 pandemic, the state does not consider that as a change to the sourcing of the employee’s compensation. For non-residents who were working in Pennsylvania before the pandemic, their compensation would remain Pennsylvania sourced income for all tax purposes, including employer withholding and three-factor business income apportionment purposes for S Corporations, partnerships and individuals. Conversely, for Pennsylvania residents who were working out-of-state before the pandemic, their compensation would remain sourced to the other state and they would still be able to claim a resident credit for tax paid to the other state on the compensation.
South Carolina
Until June 30, 2021, an out-of-state business is not subject to South Carolina’s withholding requirement solely due to the shift of employees working on the employer’s premises outside of South Carolina to remote working from South Carolina. Accordingly, the wages of a South Carolina resident employee temporarily working remotely from South Carolina instead of their normal out-of-state business location are not subject to South Carolina withholding if the employer is withholding income taxes on behalf of the other state.
Employers should contact their attorneys to assess the tax laws and any special pandemic rules for the jurisdictions where their employees are remotely working to determine their potential nexus risk and applicable withholding requirements.
The information presented is not intended to be, and does not constitute, “legal advice.” Because each situation varies, and only brief summary information is provided here, you should not use this information as a basis for action unless you have independently verified with your own counsel that it applies to your particular situation.
