Arkansas: Nonresident employee subject to state income tax
TAX ALERT |
In an uncommon, and what may prove to be controversial, decision, the Arkansas Department of Finance and Administration issued a legal opinion addressing the taxation of nonresident employees. In its opinion, the department determined that an employee of an Arkansas-based company who worked entirely from her home in Washington state was subject to Arkansas personal income tax on 100% of her compensation.
The department’s opinion hinged upon a novel interpretation of Arkansas Code section 26-51-202, which imposes an income tax on the entire net income from all property owned and every business, trade or occupation carried on in Arkansas, including income received by a nonresident from an occupation carried on within the state. Factually, the department found that the employee’s day-to-day computer programming responsibilities were tied directly to the maintenance and manipulation of computer systems at the employer’s Arkansas location, and directly impacted the employer’s ability to carry out its mission and purpose. Accordingly, the department concluded that the programmer was carrying on an occupation in Arkansas within the meaning of the statute, and was subject to Arkansas personal income tax on 100% of the compensation paid to her by her Arkansas employer.
This legal opinion is uncommon because the vast majority of states do not subject nonresident telecommuting employees to personal income tax. While a handful of states will subject a nonresident employee of an in-state employer to tax if certain requirements are met, most nonresident telecommuters pay personal income tax on their wages only to the states where they live. The department’s legal opinion may prove controversial as it seems to contradict Arkansas Supreme Court precedent in Cook v. Ayers, 214 Ark. 308 (1976), in which the court refused the state’s attempt to tax salaries of nonresidents. Additionally, while states can constitutionally tax nonresidents, there are limitations. For example, states can tax nonresidents who derive income from owning a business or property in the state. They can also tax nonresidents who physically work in the state. However, there must be a connection between the nonresident and the taxing state. The legal opinion at issue concluded that merely being an employee of an Arkansas company created the necessary connection.
The timing of this decision is important. It was released just as the country was entering the economic crisis brought on by the COVID-19 pandemic. One result of the pandemic has been a tremendous increase in the number of telecommuters. Decisions such as the Arkansas opinion, if followed by other states, could have significant consequences for employers and employees.
According to the legal opinion, employees who neither live nor physically work in Arkansas could be subject to the state’s income tax jurisdiction. A legal opinion is not precedential law, but is rather the department’s interpretation of the law. However, employers should be aware of the department’s position. If nonresident employees are subject to tax, employers will have additional or different withholding requirements. Further, employees could face income tax liabilities in their state of residence as well as in Arkansas, and may not be able to claim a credit for the tax paid to Arkansas in their home state.
For more information on remote employees, please read our article, State income tax considerations for remote employees during COVID-19. Both employers and employees should consult their tax advisors for more information.