Telecommuters (And Their Employers): Beware Of State Taxes

Despite some companies requiring a return to the office post-COVID, remote work for many appears to be here to stay. This is particularly true in the tech industry, where remote work is ubiquitous. The flexibility of having remote employees means that employers can hire superior talent without being limited to the those people who are within commuting distance of their offices. However, this also means that these remote employees may be working from states in which the company never had employees working from before, and now employers and employees are struggling to determine their state tax responsibilities as a result the employee working in a new state.

Generally, for personal income tax purposes, the employee’s physical presence dictates to which state tax is due. So, for example, an employee working from his California home for his employer in Nevada is required to pay California income taxes, since he is physically present in California doing work. However there are a handful of states that that impose a so-called (and misnamed) “convenience of the employer rule” to determine which state will tax the wages of a telecommuting employee. New York is the most infamous of these states, but, Connecticut, Delaware, Nebraska, and Pennsylvania also impose some version of the convenience rule, and New Jersey may soon as well.

Under the convenience rule, if the employee’s primary or assigned office is in a state that imposes a convenience rule, like New York, days worked outside the state by the employee out of convenience, as opposed to necessity, are treated as days worked by the employee in New York, and not from the state the employee is physically working. For example, if a New York-based tech firm has an employee that was working in New York pre-COVID, but moved to California during the pandemic and started working from home, the under New York’s rules that employee would continue to owe New York State tax on their wages. The trouble is, since they are physically working in California, they would also owe California income tax! This double tax nightmare is an issue for the employee, but also for the employer, which has the dual obligation to withhold the right amount of state taxes.

  ​The flexibility of having remote employees means that employers can hire superior talent without being limited to those people who are within commuting distance of their offices   

But there are a few options to avoid the application of the convenience rule, at least for New York purposes.

The first option is for the “100% remote” employee. If the employee does not work a single day in New York during the calendar year, the convenience rule does not apply. There is New York case law that supports this exception to the convenience rule, but there really needs to be zero New York work during the year. One work day would be ruinous!

The second option is for the employee to be assigned to an office outside of a state that imposes a convenience rule. This isn’t feasible for companies that don’t have offices all over the country. Plus, for this option to actually protect the employee and the employer, it has to be a legitimate arrangement. So the employee must actually work out of the new assigned office occasionally, and should probably not work out of the New York office more than the new office. The new office location has to actually look like the employee’s new “primary” office.

The third option is for the employer to set up what New York calls a “bona fide employer office.” The requirements for this come from a 2006 publication that created a safe harbor for employees working from home. To qualify as a bona fide employer office, the employee’s home office has to meet a variety of different “secondary” and other factors set forth in the tax department’s memorandum (see table). It’s not easy or feasible for an employee to meet at these factors, but they do provide a good roadmap for addressing the issue.

While there are ways around the convenience rule, each state’s exceptions are a little different, so employers and employees must be aware of the rules not only in the employee’s home state, but also in the state of the employee’s assigned office location. And while using one of the options explained above may resolve the double tax issue for remote employees, employers must also be aware of the payroll taxes, which may apply differently. Ultimately, certain employers will need to continue to hire remote employees to attract the best talent, but employers must also have a full understanding the current landscape with respect to withholding and payroll taxes for these remote employees and address it accordingly.