COVID-19 shut down offices and sent employees home to work — often out of state — leaving a big question about state income taxes: Should they be paid where the employees are actually working, or where the employer is located?
Alysse B. McLoughlin, a partner at McDermott Will & Emery in New York, led a Tax Section panel on this question Jan. 20 at the New York State Bar Association’s Annual Meeting. She was joined by Jennifer S. White, a partner at Reed Smith in New York, and Elizabeth Pascal, a partner at Hodgson Russ in Buffalo.
It’s a question that will remain even after COVID is a memory, because more employers are expected to allow workers to continue working at home.
“A lot of employers have realized that allowing employers to telecommute at least part of the time may work very well for the future,” said Pascal, who said she is getting “tons of calls” from employers. Those who have employees in many locations are “concerned about what that means for withholding.”
Pandemic restrictions have already sparked disagreement over how to tax employees’ income. For example, Massachusetts said last spring that workers who couldn’t be in their Massachusetts workplaces during COVID would still have to pay income taxes in the state. New Hampshire has asked the U.S. Supreme Court to overturn that rule, citing the cost to New Hampshire citizens who are employed by Massachusetts employers but are now working at their kitchen tables or home offices. New Jersey, Connecticut, and several other states have filed amicus briefs in support of New Hampshire. That case is pending.
States vary widely in their guidance on how to handle state taxation during COVID, with some saying the employee should pay taxes in the state where the employer is, and others saying the tax must be paid in the employee’s home state if the employee is working at home, McLoughlin said.
That requires employers to track not only each state’s rules, but also figure out the location of each employee, to determine how to withhold taxes, White said.
“The obligation this puts on employers is next to impossible,” White said. It gets especially complicated, the panelists said, since during COVID, employees haven’t only worked in their own homes, but also in relatives’ homes, vacation homes, rentals and so on.
New York State follows a so-called “convenience” rule, meaning that employees of a New York company who are working out of state as a matter of convenience, not necessity, must pay New York income taxes. New York has said that this applies even during the pandemic.
To get around the convenience rule, employers have several options, Pascal said. One is establishing an office out of state that the worker reports to, though this can give that state jurisdiction to impose corporate, sales or franchise taxes. (A number of states have said that the temporary, COVID-related presence of workers in the state won’t trigger such taxes – but nine have said it could.)
Another possibility is to ensure that an employee based out of state never comes into the New York office, not even once a year.
The panelists agreed that many of the rules that link taxation to a worker’s location don’t fit the realities of work, now or in the future.
“A lot of people in the future won’t be given an office, they’ll be given a laptop and told to work anywhere they want,” White said.
The panel also discussed COVID’s effect on state tax revenues, which have taken a hit as the economic lockdown threw millions out of work and slashed business revenues.
In response, McLoughlin said, states will likely look at ways to raise tax revenues including increasing corporate taxes, moving to gross receipts taxes because even companies that are not profitable pay those taxes, millionaire taxes, and more aggressive audits on taxpayers.
The panel also discussed the use of pass-through entities to get around the $10,000 limit on federal tax deductions for state and local taxes (SALT). The Internal Revenue Service recently said that these entities can claim deductions for state income tax, allowing for deductions that exceed the $10,000 limit for individuals.