The COVID-19 pandemic has been stressful for everyone. But if you worked remotely, and especially if you plan to continue doing so, don’t let a potential change to your taxes slip under the radar.
If you live in the same state where you work, working from home usually should not create any new tax concerns. But “where you live” can sometimes be a complicated question, especially for remote workers. If you own more than one home or otherwise spend a lot of time on the road, it is especially important to be clear on how the state tax authorities will determine your home base.
The two related but separate tax questions in play are “domicile” and “residency.” Your domicile is your permanent home. An individual taxpayer may be a resident of multiple states in a given year, but can only be domiciled in one. If you only have one permanent place of abode, you are likely domiciled in the state where your house, condo or apartment is located. In more ambiguous cases, no single test determines domicile. Tax authorities look at factors such as where you vote, which state issued your driver’s license, where you see the doctor, and where your family and pets live. Assuming the state where you are domiciled levies an income tax, you will owe that state tax on all your income, regardless of where you earned it.
Residency, on the other hand, is usually a factor of how much time you spend in a state over the course of a calendar year. Rules vary between states, but in many places, spending 183 days or more in the state during a calendar year can trigger residency rules. This presence test must coincide with the taxpayer maintaining a “permanent place of abode” in the state. That said, tax authorities — especially in high-tax states — have often been aggressive in determining what counts as a place of abode; staying with family, for example, may not be enough to shield you. Anyone domiciled in a state is automatically also considered a resident of that state. (Though note that being domiciled in a different state does not prevent residency.)
The distinction between being a resident and a nonresident can have a significant effect on your taxes. State residents owe income tax on all their income, while nonresidents only owe tax on income earned in the state. For more on domicile and residency, see “You Say Goodbye, States Say Hello,” by my colleague Paul Jacobs.
Working In A State Where You Don’t Live
Remote workers may face the question of working in one state and living in another. This situation is not new; nonremote workers have crossed state lines for jobs in places such as the New York City or Chicago metro areas, Kansas City, or Portland, Oregon for many years. Sometimes those workers could work from their homes part or all of the time. But the major expansion of remote work during the pandemic raised the question for many more taxpayers: If you work at home, do you owe taxes in the state where your office is located, even if you never go there?
The answer depends on the states involved. There are three potential scenarios: states with a “convenience of the employer” rule; states with a reciprocity agreement; or states with neither.
Tax professionals most strongly associate the “convenience of the employer” rule with New York, but states including Arkansas, Connecticut, Delaware, Nebraska and Pennsylvania have their own versions. Massachusetts also enacted this rule, but only during the pandemic. The rule boils down to the concept of the worker’s convenience versus the employer’s convenience. If you work from your home in a different state because your employer requires you to do so, your income is sourced to the state where you are physically working — that is, your home state. On the other hand, if your employer is merely allowing you to work from home as a benefit or because you asked to do so, the income is still sourced to the workplace’s physical location.
Here is an example. Elizabeth lives in Connecticut but commuted into New York City for work before the pandemic. New York levied tax on her income because she earned it in the state, and Connecticut levied an additional income tax because she was domiciled there, and thus a state resident. Elizabeth was able to take a credit on her Connecticut income tax return for the New York taxes she paid to offset this double taxation.
Eventually, Elizabeth tires of commuting, and asks to work from her Connecticut home part of every week. Her employer says yes, but the change was not for the employer’s own reasons. Therefore Elizabeth’s income is still sourced to New York, even if she performs much of her work within Connecticut’s borders. If she can continue to get a credit from Connecticut, nothing much has changed. But if Connecticut takes the position that work physically done in Connecticut is Connecticut-source income, regardless of where her employer is located, Elizabeth faces the prospect of taxation by both states.
States that do not have a “convenience of the employer” rule in place may sometimes have reciprocity agreements with neighboring states, and occasionally with states farther afield. For instance, New Jersey and Pennsylvania have agreed that their residents will not face income tax for income they earn in the other state. (Note that such agreements generally do not apply to municipalities; a New Jersey resident working in Philadelphia may claim a credit on her New Jersey return for income tax she paid to the city, even though she owes Pennsylvania no state income tax.)
Note that some states have “reciprocity” that is not, in fact, reciprocated. For instance, a California resident who works in Arizona will not owe tax on that income to Arizona. However, an Arizona resident working in California will need to pay California income tax. The worker may then claim a credit on his or her Arizona income tax return.
In general, if no reciprocity agreements are in place and the “convenience of the employer” test does not apply, states offer residents a credit for income taxes they paid to another state. If a New Jersey resident works in New York, that worker will get a credit on his or her New Jersey income tax return reflecting the tax paid. This arrangement can require more work at tax time, but it does mean that most workers across state lines do not face double taxation at the state level.
If income tax across state borders sounds complicated, that’s because it often is. If you live and work in different states, especially if you work more than occasionally from your home, you should consult a tax professional who can help you to be sure you are meeting your obligations in full without overpaying.
COVID-19 Effects
You may have noticed one major complicating factor for the “convenience of the employer” test: the COVID-19 pandemic. If you work from home because the office is closed, whose convenience is it for? What about if the office is partially open but you can’t come in because of a possible COVID-19 exposure or other pandemic-related guideline? If Elizabeth, our taxpayer from the previous example, could not go into her Manhattan office because it was closed, where is her income sourced while she works from her Connecticut home?
These questions are obviously quite new, so they remain somewhat in flux. However, there are some examples of actual guidance states have issued.
As we mentioned earlier, Massachusetts created a new rule for the pandemic only: Taxpayers continue to owe income tax to Massachusetts if they worked in the state before the pandemic but are now working remotely elsewhere. This rule frustrated residents of New Hampshire who commuted to Boston in pre-pandemic times. Because New Hampshire does not levy an income tax, these workers did not receive any offset for the taxes they owed to Massachusetts for income they earned there. But during 2020 and 2021, workers were not physically in Massachusetts. This arrangement led New Hampshire to turn to the U.S. Supreme Court, but in July the court declined to hear the case. This means Massachusetts’ law stands, at least until individual taxpayers try their luck in the courts.
While this result is mainly annoying for New Hampshire residents who might otherwise owe no state income tax, it could be even more aggravating elsewhere. Consider New Hampshire’s neighbor Vermont. Usually, if a Vermont resident works in New York, both states tax that income. The taxpayer can claim a credit in Vermont for the tax he or she paid to New York. However, due to the pandemic, the two states now disagree on the source of income generated by a Vermont-based employee of a New York business working remotely from Vermont. New York claims it is New York-source income, based on the convenience of the employer rule. Vermont, in turn, says work done by a remote employee in Vermont is Vermont-source income, on the basis that the employee is present in the state when working. Even a nonresident working temporarily from Vermont will owe tax to Vermont, regardless of where the worker’s employer is based. Because of this position, Vermont does not offer a tax credit for New York income taxes if the Vermont resident is working from home. The employee is taxed twice.
Not every state is this aggressive. Many New Jersey residents work in New York; these residents will receive credits for New York-source income as usual, even if they worked from home due to the pandemic. Legally, New Jersey could have taken a more aggressive position and tried to claim these wages as New Jersey-source income. But this stance would have hurt a broad swath of New Jersey residents, and the state tax authorities seemingly preferred to maintain the status quo rather than fight the situation out with New York.
As these examples demonstrate, the COVID-19 pandemic complicated an already complex landscape for remote workers. In some states, temporary relief is already going away, while in others it remains in place, creating further potential confusion for taxpayers.
What Comes Next?
Widespread vaccination has already begun to move more workers back to the offices on a full- or part-time basis. As COVID-19 prevention and treatments continue to improve, the disease will inevitably move from a pandemic to an endemic part of our lives, and workers will settle into a new normal. Evidence suggests that this new status quo will include more employees working entirely remotely, or on a hybrid schedule that includes less time in the office than previously.
While the population exodus from high income-tax states predates the pandemic, the pandemic accelerated it. Anecdotal evidence suggests that many workers have reconsidered their priorities, moving to be closer to family, to afford more living space, or to expand their families. In cases where employers allowed it, many of them kept their jobs even while moving far afield. Some workers returned to major metro centers like the San Francisco Bay Area or New York City as vaccination became widespread and offices reopened. Many others did not. Companies dedicated to keeping their far-flung workforce will need to consider offering the ability to work across state lines; in turn, employees who accept such offers will have new tax considerations to keep in mind.
We would not be surprised to see more states impose convenience of the employer rules or similar regimes to try to hold onto income tax revenue as workers relocate. We have seen similar shifts to reflect technological changes before. States’ struggle to impose sales tax on online and other out-of-state retailers led to a physical presence test that lasted for 25 years until the U.S. Supreme Court reversed itself in 2018. Whether state income tax will follow a similar course is unclear, but it does seem likely that more uniform rules will develop if remote work across state lines becomes routine. Alternatively, Congress could step in and restrict or standardize states’ ability to tax remote workers based elsewhere. In the meantime, imposing more stringent tax regimes carries risks for states that try it. Companies where all or most workers can work remotely may choose to leave states with such restrictions in order to attract employees from low- or no-income tax states, and to simplify their own bookkeeping.
Employers can face state penalties if they fail to withhold taxes when they should have. There are some limited exceptions. Some states, including Arizona and Hawaii, do not require employers to withhold taxes if the employee in question works there for 60 days or fewer in a calendar year. In general, though, employers have a strong incentive to know where their employees are working. If remote employees are based out of an established physical office, generally the employer will withhold tax (if necessary) for the state where the office is located, even if the employee works part of the time remotely in another state. But for employees who are fully remote, employers will have to weigh the competitive pressure to recruit nationwide talent against the added complications of doing business in new states.
For many businesses, there is no going back to the expectation that all employees come in person to the office every day, or even most days. Remote work comes with many upsides for both employer and employee. It is not going away. But for employees who work across state lines, income taxes are likely to remain complex for years to come.
EDITOR'S NOTE: Former senior client service associate Victoria Romaniello also contributed to this article.
