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Some Remote Workers (and Their Employers) Wrestle With State Income Tax Issue; It Likely Won’t End Once the Pandemic Ends

Some Remote Workers (and Their Employers) Wrestle With State Income Tax Issue; It Likely Won’t End Once the Pandemic Ends Background Image

Many employees during the COVID-19 pandemic are asking: To which state must I pay income tax?

Potentially affected are employees who resided in State A and commuted to work in State B before the pandemic but are now working remotely in State A.  Also affected are employees who lived and worked in the same state prior to the pandemic but temporarily relocated to another state to work remotely.  Their employers have concerns, too.  Employers have state income tax withholding obligations.  Equally significant, if the employer does not otherwise have a physical or economic presence in a state where employees are working remotely, is the employer now subject to income tax in that state?  And while this might seem to be a “temporary” problem, it may not be — particularly if (as many suspect) remote work continues to increase post-pandemic.

Out-of-State Commuters Working From Home During Pandemic

An individual’s state of residence can tax all of the individual’s income irrespective of where the income is earned, but the individual is generally allowed a credit for income taxes paid to other states.  Thus, if an individual lives in State A but commutes to work in State B, both states may impose income tax on the individual’s income earned in State B.  State A will then allow the individual to claim a credit for the income taxes paid to State B.  Will State B continue to tax the individual (and require the employer to withhold) if the individual no longer continues to commute to work but instead works from home in State A during the pandemic?

Most states have not addressed this question.  But New York, Massachusetts, and Pennsylvania, which have numerous “out of state” workers who commute from neighboring states, have issued guidance.  In general, these three states have maintained the status quo during the pandemic.  That is, individuals who commuted into work before the pandemic are to be treated as still working in the office, even though they are telecommuting from another state.  These three states are applying this rule, no doubt, to mitigate the already significant decline in state tax revenues caused by the pandemic.

Massachusetts’ taxation of New Hampshire residents working for Massachusetts employers has prompted New Hampshire to sue Massachusetts in the United States Supreme Court.  New Hampshire does not have a state personal income tax.  It argues that the Massachusetts regulation, which taxes income earned by residents of New Hampshire for services performed in New Hampshire, violates the commerce and due process clauses of the U.S. Constitution.  The Court has asked the acting U.S. Solicitor General to weigh in on whether the Court should hear this case pursuant to its original jurisdiction for suits between States.

Temporary Relocation from State of Residence and Workplace

What about the individual who resides and works in State C but is working remotely from State D during the pandemic?  Again, many states have issued no guidance addressing which state gets to tax the income of the employee.  In the absence of guidance, employees and employers must apply those states’ general rules to determine taxability.  To add to the confusion, even the states that have addressed the issue have adopted conflicting rules — with some states saying that the income of the telecommuter is taxed in the employer’s state (some states apply this rule only if the employer’s state is taxing the employee’s income) and other states saying the income is taxable by the state where the work is performed (usually pursuant to the state’s pre-existing tax laws).

Unfortunately, this state of affairs leaves employees and employers no choice but to review and comply with a myriad of different rules.  And Congress has failed to step in and pass legislation that could provide much-needed conformity and predictability.

Taxability Post COVID-19

The guidance that has been issued by states to date is limited to the emergency caused by the COVID-19 pandemic and will lapse once that emergency is declared to be over.  What is likely to continue is the desire of employees to work remotely.  And it is anticipated that many employers will encourage, require, or facilitate remote working after things are “back to normal.”  The taxability issues discussed above are thus likely to continue to be relevant.  And because states will undoubtedly continue to adopt various approaches to these issues, there will be no one-size-fits-all solution and employers should consult their tax advisors.

Please visit our Coronavirus: Preparation & Response series for additional resources we hope will be helpful.

This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.