More than a year ago, the nation and many states required businesses to shut their doors to employees and customers due to a growing national emergency. People began to work from their home or other property, which in some cases was not in the same state as the office where they normally worked. Some think that working from home is the best of times and some believe it is the worst of times. Most are unaware that this can create an unintended consequence of changing the state(s) for which they are subject to income tax. Figuring out state tax liabilities can be very complicated. Therefore, you should contact your tax professional for assistance.
According to a November 6, 2020 CNBC article, the American Institute of CPAs found that “More than half of adults who worked remotely during the pandemic are unaware that they could face tax consequences because they didn’t update their tax withholding to reflect their new location.” In addition, seven out of ten remote workers “were unaware that telecommuting from a different state could affect the amount of taxes owed.”
Each state defines who is subject to its income tax differently. Two main terms to understand with respect to how states determine this are domicile and statutory residency.
- Domicile: This is what some call a “permanent residence” for which you only have one. It is where you are registered to vote, where your kids are growing up, where you keep all the family heirlooms, where your place of worship is and from where your state ID or driver’s license is issued. In other words, this is your “home.”
- Statutory Residency: You can have and/or stay at multiple properties in as many states as you desire. This can result in you having statutory residency in which the state(s) can tax you as a resident. In many states, the concept of statutory residency is one in which you meet the following two standards:
- You have a permanent abode in the state; and
- You are present in the state for 183 days or more.
As there are 50 states and Washington, D.C., numerous possibilities should be considered for how working from home (“WFH”) and in different locations can impact your state or district tax obligations.
COVID-19 has created an issue as to how the above terms are determined because the employee is now forced to work in an alternative location than their normal office. Many states have reciprocity agreements where this would not create this problem. These agreements allow a taxpayer residing in one state to work in another state without having taxes withheld from the non-resident state. For example, an employee working for a Washington, DC company and living in MD, would have only MD income taxes withheld and no liability to DC for these wages. There are also states that do not have income taxes. These include AK, WA, WY, NV, TX, TN, SD, NH and FL. Other state policies, however, are not as clear.
One of these rules is called “convenience of the employer,” meaning that the state will tax remote employees based on the location of the employer’s States that have implemented this include AR, CT, DE, MA, NB, NY and PA. New Jersey appears to impose a similar rule if an employee is working in the state due to the pandemic. In this case, neither domicile nor residency play a role in determining whether these states will consider you a taxpayer. You are a taxpayer solely if your employer’s office is located in that state.
Most states, as mentioned above, will consider you to be a taxpayer if you have a domicile or residency there and you work there for more than 183 days. This determination has been made more complex by the pandemic as more people are forced to work elsewhere. You could work from your home, from a vacation or rental property, or from a temporary office. Each of these could be in a different state. Even if you do not hit the 183-day number, in some states you could be required to file a non-resident tax return and possibly end up paying some tax. For example, if you work in Arizona for 60 days, your employer must withhold taxes even if you are a nonresident employee. As a more extreme example, just one day of work in New York could subject you to tax. Determining your tax obligations is very complex and would have to be analyzed based on all facts and circumstances.
There may also be tax consequences where your domicile or residence is in a state that has no income tax and you work for an employer in another state that does. The taxing state may claim that the employee is a taxpayer even though they are not working specifically within that state. This is precisely the issue that New Hampshire has brought to the U.S. Supreme Court. In late 2020, it filed a lawsuit against Massachusetts for its “unconstitutional tax grab” of taxing NH residents working remotely for Massachusetts firms. It will be interesting to see how this suit plays out.
Of course, you could be, and possibly already are, the winner of the “State Tax Trifecta.” For example, your company’s offices from which you normally work are in New York City. Your full-time personal residence is in New Jersey and you also own a residence in Massachusetts that was used as a short-term rental before the pandemic. During the pandemic, you decided to WFH in Massachusetts. As such, based on current regulations, there is the possibility that you can be taxed in all three states. All may not be lost as some states, including Connecticut and New Jersey, offer a credit for residents paying income tax in other states.
State and federal governments are fully aware of these issues and are working to provide remedies and guidance to eliminate the possibility of double taxation. As recently as January 1, 2021, Congress introduced H.R. 429, which proposes to restrict the ability to tax an employee to their resident state and to states where they are present and working for more than 30 days.
As of this time, legislation impacting the determination of state tax obligations is quite fluid. We highly recommend that you reach out to your tax advisor for guidance on state tax reporting and for beneficial tax planning.