The COVID-19 pandemic is rapidly changing how businesses are managing their workforces. Millions of employees worked remotely during the pandemic. The spring shutdown of the economy led to massive lay-offs and furloughs. Civil unrest has prevented some businesses in city-centers from reopening as pandemic stay-at-home orders are relaxed and states move into new phases of reopening. As uncertainty about the COVID-19 recovery and the distressed economy continues, many employers and employees may choose to maintain remote workforce arrangements.
The benefits of a remote workforce are clear. From a public health perspective, offices do not have to reengineer work spaces to accommodate social distancing. Cubicles no longer need higher walls or even ceilings. Offices can avoid restocking costs or closing down kitchens and coffee machines. Fringe benefits such as daycare, transportation, and parking paid by employers are reduced, and costs to employees to commute are all but eliminated.
However, the nature of a remote workforce may not just benefit employers struggling to respond safely and appropriately to COVID-19. Employers may find expensive downtown office spaces are no longer needed, or find more value in a smaller real estate footprint. Employers near state lines may find moving operations to neighboring jurisdictions could decrease state and local tax expenses without sacrificing the quality of the product or service offered.
With all of those workforce dynamics in mind, there are a number of state and local tax considerations for remote workforces. Several of those are described below.
Nexus footprint and Public Law 86-272 considerations
A remote workforce can dramatically affect a company’s state tax nexus footprint. A company is generally considered to be doing business and subject to a state’s tax laws if the company has employees working in the state. Businesses with employees working remotely, as they would have in an office location, could find they are subject to a state’s tax laws based merely on the presence of the employee.
Establishing nexus through remote workforce could cause new income and franchise tax and sales and use tax obligations if nexus was not previously established in the employee’s resident state. An employee living in a different state would normally not create nexus for the employer, but as a remote worker, that employee attributes presence to the employer through their performance of their employment duties at home. Importantly, a business can establish nexus through many other mechanisms beyond the presence of employees, including through property in the state or based on sales into a state.
Additionally, some businesses may have had nexus in a state, but were otherwise not subject to an income tax liability because of Public Law 86-272, the federal safe harbor prohibiting a state from imposing a net income tax on a seller's business activity if it is limited to the solicitation of orders for sales of tangible personal property. An employee working remotely from their residence may cause that protection to be lost.
Finally, establishing new nexus for any state tax due to a remote workforce could create and complicate registration and compliance obligations. Businesses subject to tax in new jurisdictions may result in remarkably different apportionment factors for income tax purposes. Businesses selling taxable goods or services in those jurisdictions may need to start charging and remitting sales taxes as well.
Withholding individual income taxes
With new remote employee scenarios, businesses must determine where, and in some cases if, they must withhold state and local income taxes. Generally, individual income tax jurisdiction is governed by an employee’s state of residence or state of employment. However, there are exceptions to this rule. Some states will subject a nonresident employee of an in-state employer to tax on 100% of their wages if certain requirements are met. Other states and certain localities will subject any employee activity occurring in their jurisdiction to tax. While some states provide for reciprocal individual income tax agreements, most states do not. Navigating the application of nonresident individual income tax rules can be exceedingly complex.
The state COVID-19 nexus and withholding response
Since the beginning of the pandemic, over a dozen states have provided guidance in response to increased remote work arrangements. In some cases, these states have temporarily excluded remote workforce from certain nexus or withholding determinations. However, most of this guidance has one characteristic in common: it applies to the duration of the COVID-19 emergency. Businesses with current remote workforces and businesses considering maintaining some amount of remote workforces must carefully review any state guidance temporarily providing a nexus exemption.
Additionally, some of the states that have addressed nexus due to remote workforces because of COVID-19 have not addressed Public Law 86-272. A business may have established nexus in a state, but may not have had an income tax liability because their activities were protected, e.g., limited to the solicitation of tangible personal property. However, the presence of a remote employee may cause the loss of Public Law 86-272 protections and thus create an income tax exposure for the business.
States that have addressed either nexus or withholding concerns due to remote workforces include Alabama, District of Columbia, Georgia, Illinois, Indiana, Iowa, Massachusetts, Minnesota, Mississippi, New Jersey, North Dakota, Pennsylvania, Rhode Island and South Carolina. Not all of the guidance provided is new, or a change from the state’s historical approach to nexus or withholding. It is imperative businesses read the guidance closely and understand when and for how long it applies.
The RSM State and Local Tax group can assist employers in assessing the state and local tax ramifications of remote workforces. Businesses with remote workforces could be creating new nexus jurisdictions or withholding requirements due to the nature of an employee working from their residence. Many employers may be considering extending remote work arrangements well past the early stages of COVID-19 recovery, making it that much more important for businesses to understand how these arrangements can impact their state and local tax footprint.
State and local tax concerns pertaining to remote workforces are further explored in RSM’s article, State income tax considerations for remote employees during COVID-19. Additionally, businesses are turning to virtual internships and virtual boards of directors meetings to maintain social distancing and reduce costs. Virtual work arrangements also have similar and surprising impacts on the state and local tax footprint of a business. For more information, please contact your state and local tax adviser for questions about these new dynamics.