Exclusive Interview with McGuireWoods’ Lead Tax Litigator Craig Bell
Remote Work: Payroll Tax And Compliance Risks HR Should Be Aware Of
Posted on 12-29-2020, Read Time: 5 Min
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“Business must understand tax and withholding consequences come into play with respect to their employees. You have to know the state tax laws that impose obligations on employers as to withholding of income and payroll taxes from employees’ compensation before payment to employees. Similarly, you must also understand there is no single universal rule. Each state has their own rules and requirements. These rules may have some similarities among states, but they are not uniform,” notes Craig Bell, Partner, McGuireWoods LLP. |
Craig is Head of the law firm’s State and Local Tax Practice Group, as well as the Tax Litigation Practice Group. In an exclusive interaction with HR.com, he talks about the various aspects of payroll tax and compliance that HR should be mindful of when employees are working remotely because of Covid-19.
Exceprts from an interview:
Q: What are the payroll and compliance challenges of remote work and how should employers approach the issue?
Craig: The Covid-19 pandemic is proving to be a nightmare for many businesses who closed their brick and mortar offices and transitioned employees to remote work.
While initially many clients thought the switch to virtual or remote work outside of the normal physical office would be a relatively short-term event, those thoughts are gone as employers realize the “working remote” arrangement will likely continue well into 2021, before returning to the office in some form (limited, phased, etc.) becomes a reality.
I am receiving more calls from clients about what they need to be doing to get some semblance of control over the situation. Questions regarding what impact do employees working remotely in states where the business does not have physical offices have with regard to creating income tax nexus for the business (employer) in the “new” state due to temporary teleworking due to the pandemic have become more frequent as well.
However, another group of questions are coming with increased regularity from HR personnel. They want to know the impact of a remote worker who is residing and working from another state due to the Covid pandemic.
First, the business must understand tax and withholding consequences come into play with respect to their employees. You have to know the state tax laws that impose obligations on employers as to withholding of income and payroll taxes from employees’ compensation before payment to employees. Second, you must understand there is no single universal rule. Each state has their own rules and requirements. These rules may have some similarities among states, but they are not uniform.
The problem becomes more burdensome when your closed office is near a state border. Employees may take up temporary living accommodations with out-of-state family members or at vacation homes as opposed to the employee’s traditional residence. How does the employer know where the employee is living during the pandemic related office closing?
By the time an employer’s human resources department learns that an employee is riding out the Covid pandemic by living and working remotely in another state, the obligation of the employer to be withholding income and payroll taxes at rates applicable in the employee’s temporary new out-of-state residence will have undoubtedly been triggered. Now HR must figure out the best way to handle the issue.
While initially many clients thought the switch to virtual or remote work outside of the normal physical office would be a relatively short-term event, those thoughts are gone as employers realize the “working remote” arrangement will likely continue well into 2021, before returning to the office in some form (limited, phased, etc.) becomes a reality.
I am receiving more calls from clients about what they need to be doing to get some semblance of control over the situation. Questions regarding what impact do employees working remotely in states where the business does not have physical offices have with regard to creating income tax nexus for the business (employer) in the “new” state due to temporary teleworking due to the pandemic have become more frequent as well.
However, another group of questions are coming with increased regularity from HR personnel. They want to know the impact of a remote worker who is residing and working from another state due to the Covid pandemic.
First, the business must understand tax and withholding consequences come into play with respect to their employees. You have to know the state tax laws that impose obligations on employers as to withholding of income and payroll taxes from employees’ compensation before payment to employees. Second, you must understand there is no single universal rule. Each state has their own rules and requirements. These rules may have some similarities among states, but they are not uniform.
The problem becomes more burdensome when your closed office is near a state border. Employees may take up temporary living accommodations with out-of-state family members or at vacation homes as opposed to the employee’s traditional residence. How does the employer know where the employee is living during the pandemic related office closing?
By the time an employer’s human resources department learns that an employee is riding out the Covid pandemic by living and working remotely in another state, the obligation of the employer to be withholding income and payroll taxes at rates applicable in the employee’s temporary new out-of-state residence will have undoubtedly been triggered. Now HR must figure out the best way to handle the issue.
Q: Should companies withhold wages earned by employees based on the location of the remote employees?
Craig: You must look at the particular rules of the state where the employee is now living and remotely working. The state where an employee principally resides generally has primary authority to tax the employee’s income. However, for state taxes, withholding from employment income is typically based on where the employee actually works. If an employee principally resides in one state but works in another state, the employee is generally subject to withholding rules of the principal work state. However, the employee can take a credit for taxes paid to the work state against tax liability otherwise owed to the employee’s state of residence.
Some border states enter into reciprocal agreements between and among several states to permit withholding to be made where the employee resides, as opposed to where the employee works, provided both states treat the employees of the other state in a similar manner. So you can see how important it is for the employer’s HR personnel to know the relevant state tax laws where their employees are temporarily residing due to the Covid pandemic.
Another complication may be where a state uses the “convenience of the employer” test as to where an employee’s wages or compensation is to be sourced. Under the convenience of the employer test, the compensation is sourced to the employer’s location where the employee is based unless the arrangement is for the employer’s necessity, not the employee’s convenience.
States that use the “convenience of the employer” test include Connecticut, Delaware, Nebraska and New York. Under the convenience of the employer test, a remote worker will have wages withheld at rates for the state where the employee’s office is physically located, and not the state where the employee may be remotely working.
This situation creates problems as both states may seek to be the primary tax state, especially where the remote worker is in the other state and reaches the state’s threshold number of work days for states that have a threshold, thus triggering the state’s withholding requirements.
Some border states enter into reciprocal agreements between and among several states to permit withholding to be made where the employee resides, as opposed to where the employee works, provided both states treat the employees of the other state in a similar manner. So you can see how important it is for the employer’s HR personnel to know the relevant state tax laws where their employees are temporarily residing due to the Covid pandemic.
Another complication may be where a state uses the “convenience of the employer” test as to where an employee’s wages or compensation is to be sourced. Under the convenience of the employer test, the compensation is sourced to the employer’s location where the employee is based unless the arrangement is for the employer’s necessity, not the employee’s convenience.
States that use the “convenience of the employer” test include Connecticut, Delaware, Nebraska and New York. Under the convenience of the employer test, a remote worker will have wages withheld at rates for the state where the employee’s office is physically located, and not the state where the employee may be remotely working.
This situation creates problems as both states may seek to be the primary tax state, especially where the remote worker is in the other state and reaches the state’s threshold number of work days for states that have a threshold, thus triggering the state’s withholding requirements.
Q: Should employees file a non-resident tax return in the state where he/she is remotely working?
Craig: Typically the answer will be yes unless the employee is working in another state other than their home state due to the pandemic, and the home state and the remote working state have a reciprocal agreement allowing the home state to have tax authority regarding withholding (e.g., Virginia, District of Columbia, Maryland).
However, if the employee is working in a state other than their principal state of residence or their principal work state, and they reach that state’s threshold number of days to be considered a statutory resident (usually 183 days), (employers may have an obligation to withhold taxes from the employee of the remote worker’s state withholding level).
If this result occurs, the remote work state will consider the remote work employee to be a resident for income tax purposes. The remote worker will then have two states that each consider the remote worker a resident and both states will seek a full year resident tax return.
However, if the employee is working in a state other than their principal state of residence or their principal work state, and they reach that state’s threshold number of days to be considered a statutory resident (usually 183 days), (employers may have an obligation to withhold taxes from the employee of the remote worker’s state withholding level).
If this result occurs, the remote work state will consider the remote work employee to be a resident for income tax purposes. The remote worker will then have two states that each consider the remote worker a resident and both states will seek a full year resident tax return.
Q: What are the additional state taxes employees can incur next year if they continue to work remotely from different states?
Craig: Depending on the remote work employee’s job responsibilities (i.e., sales representative) some states may have local gross receipts taxes (i.e., San Francisco’s gross receipts tax) and business personal property taxes if the remote work employee is furnished with company employer property such as inventory, company automobile, computer equipment and printers, etc.
Q: Which are the new and proposed standards that will affect or are likely to affect reporting in 2021?
Craig: I will keep my remarks to this question on efforts by a number of states that have adopted Covid-related guidance related to teleworking.
A number of states have adopted temporary Covid rules to retain rules in close proximity to their normal rules or even relaxed requirements in various ways to accommodate those employees disrupted by the pandemic. For example, Illinois allows a thirty-day grace period before employees working in the state are subject to Illinois withholding. New Jersey allows for any telework income to be sourced according to the employer’s jurisdiction. However, working in the state for over 183 days will establish tax residency and make all income subject to New Jersey withholding. Pennsylvania says working remotely during Covid will not change the source of the employee’s income; it is still sourced based on the pre-pandemic work location. South Carolina says non-residents that usually work in the state are still subject to South Carolina withholding when teleworking from another state. On the other hand, residents temporarily working from home rather than their usual workplace outside the state are not subject to South Carolina withholding if the employer is withholding taxes for them in the state where they usually work.
Employers must also stay on top of these new Covid laws and administrative changes. Generally employees teleworking from a state where the employer otherwise does not have nexus may create nexus with that state. However, a number of states have waived nexus for businesses with remote employees during the pandemic or active official stay-at-home orders (e.g., D.C., Georgia, Indiana, Iowa, Massachusetts, Mississippi, New Jersey, North Dakota, Pennsylvania, and South Carolina to name a few).
As you can see from the foregoing sample of states, the Covid pandemic moves some states to loosen the normal telework rules for employees so as not to capitalize and make a difficult situation even worse. However, many other states have adopted not temporary rules for the pandemic. All of this makes the job all that more difficult for the human resources department to adopt a plan of compliance.
A number of states have adopted temporary Covid rules to retain rules in close proximity to their normal rules or even relaxed requirements in various ways to accommodate those employees disrupted by the pandemic. For example, Illinois allows a thirty-day grace period before employees working in the state are subject to Illinois withholding. New Jersey allows for any telework income to be sourced according to the employer’s jurisdiction. However, working in the state for over 183 days will establish tax residency and make all income subject to New Jersey withholding. Pennsylvania says working remotely during Covid will not change the source of the employee’s income; it is still sourced based on the pre-pandemic work location. South Carolina says non-residents that usually work in the state are still subject to South Carolina withholding when teleworking from another state. On the other hand, residents temporarily working from home rather than their usual workplace outside the state are not subject to South Carolina withholding if the employer is withholding taxes for them in the state where they usually work.
Employers must also stay on top of these new Covid laws and administrative changes. Generally employees teleworking from a state where the employer otherwise does not have nexus may create nexus with that state. However, a number of states have waived nexus for businesses with remote employees during the pandemic or active official stay-at-home orders (e.g., D.C., Georgia, Indiana, Iowa, Massachusetts, Mississippi, New Jersey, North Dakota, Pennsylvania, and South Carolina to name a few).
As you can see from the foregoing sample of states, the Covid pandemic moves some states to loosen the normal telework rules for employees so as not to capitalize and make a difficult situation even worse. However, many other states have adopted not temporary rules for the pandemic. All of this makes the job all that more difficult for the human resources department to adopt a plan of compliance.
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