8920 / What state tax issues should employers consider when evaluating whether to permit ongoing remote work arrangements?

Editor’s Note: While the state tax issues discussed below are important, employers should also consider their obligations under the FLSA. The DOL has released guidance outlining its stance on whether remote workers must be paid for short breaks taken throughout the course of the day. Pursuant to the DOL guidance, any break that is less than 20 minutes is compensable time if the employee is a non-exempt employee. That’s true regardless of the purpose of the break. The guidance is based on the principle that employees commonly take short breaks throughout the day regardless of whether they are located on site or remote–and that these breaks reduce fatigue and allow the employee to be more productive throughout the workday. The DOL differentiates these short breaks from longer meal breaks, or longer breaks to handle household issues, such as making dinner or caring for children. Note that this guidance only applies to employees who are not exempt from FLSA overtime requirements. While the guidance does not have the force of law, it can be relied upon by courts in determining whether employers have complied with FLSA rules.¹

Countless employers permitted remote work arrangements for the first time in response to the COVID-19 pandemic in 2020. Due to the ongoing nature of the pandemic (and the realization that many workers are equally productive and even prefer to work at home), some employers and employees wish to continue some of these arrangements even as many workspaces begin to reopen in a post-pandemic environment. However, before employers allow employees to continue working at home, there are many state-level tax issues that must be considered. Employers should have plans and policies in place to prevent adverse tax consequences, both for the employer and employee.

Application of state and local taxes is determined based on “nexus” concepts. Typically, there must be a substantial connection between a taxpayer and the state or locality that is attempting to tax an out-of-state taxpayer (assuming the taxpayer does not reside in the state). When all employees report to duty in a central location, this is rarely an issue—the location of the worksite controls which state and local taxes apply.

However, many remote workers live and work in neighboring states. Others have relocated to different states in reliance on pandemic telework arrangements. Remote workers can create the required substantial nexus by their physical presence while working remotely within a taxing jurisdiction even if the employer does not have a substantial connection to that jurisdiction.

Many states enacted emergency measures to prevent unintended tax consequences and clarify when employers were required to withhold state-level taxes during the height of the COVID-19 pandemic.

For example, Massachusetts enacted telecommuting rules that provided that wages paid to a non-resident employee working remotely due to the COVID-19 pandemic would be sourced according to the location where the employee performed work prior to the pandemic. In other words, during the pandemic, Massachusetts temporarily taxed income earned by nonresident employees of Massachusetts employers who were telecommuting for pandemic-related reasons. However, Massachusetts (and many other states) have now begun rescinding these emergency rules (after September 13, 2021, Massachusetts state tax will apply if the work is actually performed in Massachusetts).²

In New Jersey, income is taxed where the employee actually performs the work. People working remotely for an out-of-state business from a home in New Jersey must usually pay New Jersey income taxes. However, an emergency pandemic rule waived this requirement—so that, for example, if a New Jersey resident worked remotely for a company in New York, the New York employer could continue to withhold income taxes as though the employee continued to work in New York. The emergency rule was allowed to expire as of October 1, 2021.³

Note, however, that many states (including New Jersey) offer a tax credit for income taxes paid in another state to prevent double taxation.

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Planning Point: Some states have rescinded their emergency rules and others have extended those rules. Any employer who elects to permit out-of-state remote work should work closely with competent tax counsel to evaluate their particular withholding obligations, depending upon the employer’s location and the location of out-of-state remote workers as these state-level regulations continue to evolve.

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Although many states offer tax credits to prevent double taxation, employers may be required to withhold state-level income taxes for employees working in a different state. Employers should carefully consider the administrative burden a new state or local tax obligation may have on a company remember, of course, that employers can be held liable for taxes that are not properly withheld.

In most states, the employer withholds for the state where the employee works (often, the employee must work in the state for a certain period of time for this withholding obligation to apply). Now, it is possible that the employer may need to withhold based on the employee’s residence (which is often also where the work is performed).

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Planning Point: Some states have reciprocal agreements with neighboring states that must be analyzed (and may be controlling) when determining an employer’s withholding obligations.

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