The general disruption in life caused by COVID-19 has accelerated the pace of the mobilization of the workforce, creating tax policy considerations that have been slowly surfacing over the past decade.
“The fact that states, employers and workers were all suddenly forced into remote work settings has provided an unexpected opportunity for a discussion about how best to tax an increasingly mobile workforce,” said Joyce Beebe, fellow in public finance at Rice University’s Baker Institute for Public Policy.
“State tax and regulatory issues, home office reimbursement for employees and workplace benefits are starting points to engage in tax policy dialogues for tomorrow’s workforce and the future of work,” she said. “For employees, state rules generally set out the principle that employee wages are attributable to the state where the employee performs his or her work, which means an employee’s physical location dictates where the state personal income tax is due. For many employees, the physical location of where they work, their employer’s place of business, and their residence are in the same state. However, for workers who telecommute, two or three of these locations may not align.”
Traditionally, affected workers are the ones who live close to state lines and commute to a different state to work, she indicated. “As a solution, about 16 states and Washington, D.C., have reciprocity agreements with neighboring states that allow these workers to file and pay taxes in their state of residence, which provides certainty to taxpayers and avoids double taxation,” she said. “And for employees temporarily displaced by the pandemic and working from another state, slightly over a dozen states and Washington, D.C., issued guidance confirming that the remote workers will not be considered in-state workers.”
For employers, having employees working in another state may create physical presence nexus, Beebe observed. “Having nexus in a certain state could lead to several state taxes on the employer, including income, sales and use, or gross receipts taxes. There could also be city, county or municipal-level taxes. The issues can become complicated for employers very quickly.”
When a multistate business determines the amount of taxable income attributable to a particular state, an apportionment formula is used to determine the proper share of the company’s income derived from that state. “Most states either use a three-factor formula based on the company’s sales, payroll and property in the state, or a single-factor formula of sales to determine the amount of taxable income that belongs to the state,” she said. “A lack of remote worker relief at the state level could mean that, when an employee is physically present in a state where the company does not typically have nexus, the state can assert that the wages paid to the employee contribute to the payroll factor of the formula.”
In addition, the remote workers may possess inventory or company-provided equipment, including computers, at the employees’ physical location, she noted: “Some observers believe this could add to the employers’ computation of property in the apportionment formula.”
And finally, under market-based sourcing, most states source the revenue from the provision of services to a state where the services are delivered or received, according to Beebe.
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“But some states require service revenue or revenue from licensing of intangibles to be sourced to the state where the income-producing activity occurred, based on the relevant costs of performance,” she said. “These states can claim that the compensation paid to employees who are telecommuting from their states contributes to the generation of revenue, therefore requiring some of the revenue to be sourced to those jurisdictions.”
Industry experts advocate nexus tracing, which allows them to track where their employees are working. “This avoids tax filing or payment surprises for employers during tax-filing season, and also allows employers to accurately fulfill tax withholding obligations,” she said.
Federal attempts at a solution were unsuccessful in 2016 and 2019, Beebe observed. “As a result of the pandemic, the Remote and Mobile Worker Relief Act of 2020 proposed to tax workers either in their state of residence or in the state where they are physically present,” she said. “Businesses favor this proposal because of the compliance challenges generated by states’ sporadic and inconsistent actions. However, observers believe the bill has a slim chance of becoming law, because states don’t welcome a federal preemption of state tax issues.”
“In the absence of a federal solution, states that have not issued guidance for 2020 should clarify that the presence of remote workers during the pandemic is insufficient to create nexus,” she concluded.