Do You Know Where Your Employees Are?
Do you need a payroll tax review? As if complying with payroll-related taxes isn’t difficult enough, with telecommuting becoming the new normal due to COVID-19, do you know where your employees are actually working and are you withholding payroll taxes in the correct state?
By: Jeff Glickman, SALT Partner
Hello 2021, it’s great to see you. Employers haven’t been able to say the same to their employees this year. One of the biggest compliance headaches in multi-state tax is employment-related payment obligations, namely, payroll withholding and unemployment contributions, particularly for companies where employees do significant traveling within the United States. Prior to state withholding issues facing employers due to COVID-19, state employment tax compliance is made difficult due to a variety of factors:
- State withholding thresholds: Many states apply a “first day, first dollar” approach to state income tax withholding, meaning that the moment and employee performs services in a state, the employer has an obligation to withhold and remit income tax from the employee’s compensation.
- Reciprocity Agreements: Some states have reciprocity agreements, which requires the employer to comply with income tax withholding in the state where the employee lives rather than where the employee works.
- “Convenience of the Employer” Rules: Several states employ this rule, which essentially requires withholding based on the employer’s office location as opposed to where the employee is performing services, if the employee is working at another location for “convenience.” More details about this rule are discussed below.
- State Unemployment Contributions: While state payroll withholding is generally based on where the employee performed services, which may result in allocating an employee’s total compensation among various states, state unemployment contributions do not follow that rule. Generally, only one state will receive all unemployment contributions for a particular employee based on a hierarchical rule structure similar to the state corporate payroll factor apportionment sourcing rules.
There are six states that follow the convenience of the employer rule: Arkansas, Connecticut, Delaware, Nebraska, New York, and Pennsylvania. These rules provide that an employee is deemed to be performing services at the employer’s location if the work is being performed elsewhere for “convenience.” Typically, unless the employer is requesting, or the job requires, that the work be performed elsewhere, withholding will be required based on the employee’s assigned location.
For example, assume a New Jersey resident lawyer works for a law firm in New York City and she chooses to commute to the office three days a week and work remotely the other two days. Since the job and the employer are not requiring her to work in New Jersey, the law firm is required to withhold New York income taxes from her wages for all five days. Alternatively, if she is litigating a case and is required to spend two weeks in a New Jersey courthouse, those days would be subject to New Jersey withholding (assuming any applicable thresholds are met).
However, the convenience rule does not apply solely to the typical telecommuter who works some days in the office and some at home. Earlier this year, the Arkansas Department of Finance and Administration (DFA) issued Legal Opinion No. 20200203. In that situation, an employee who worked as a computer programmer at the Arkansas location of her employer moved permanently to Washington state (no personal income tax) in the middle of 2017. Following the move, she continued to work for her Arkansas employer. Arkansas ruled that the employee is required to file an Arkansas income tax return and pay tax on the income related to her employment even though she does not physically perform any work in Arkansas.
In addition to the above factors, which already make state employment tax compliance difficult, states are now layering on special rules related to COVID-19, creating even more complexity and complication. Several months ago, we wrote an article discussing the nexus and withholding guidance that some states issued in response to employees working in alternative locations.
More recently, Massachusetts adopted a regulation stating that if a non-resident employee was performing services in Massachusetts for an employer immediately prior to the state’s COVID-19 state of emergency, then the work performed by that employee outside of Massachusetts due to a “pandemic-related circumstance” will continue to be treated as Massachusetts-source income for personal income tax and withholding tax purposes. This regulation applies for wages earned from March 10, 2020, through the earlier of December 31, 2020 or 90 days after the date that the Governor gave notice of the state’s COVID-19 state of emergency.
Several days later, New Hampshire, which borders Massachusetts and does not impose a personal income tax, sued Massachusetts over this rule, claiming that it unconstitutionally taxes New Hampshire residents that are working in New Hampshire. Such employees were not taxable on the wages they earned while performing services in New Hampshire for their Massachusetts employer before COVID-19.
As we enter 2021, now is the time for employers to review their withholding compliance policies and data, as well as analyze if they are withholding payroll taxes unemployment insurance contributions to the appropriate states. Aprio’s SALT team has been following these rules throughout the pandemic and is ready to assist businesses to make sure that they comply with their multi-state tax obligations and do not incur unexpected liabilities and penalties. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.
This article was featured in the November/December 2020 SALT Newsletter.
 830 CMR 62.5A.3 (October 16, 2020). The rule also recognizes that other states may have similar rules and thus it provides that a Massachusetts resident who worked outside the state before COVID-19 will be eligible for a credit for income tax paid to that other state and the employer is not required to withhold Massachusetts income tax while the resident is working in Massachusetts due to a Pandemic-Related Circumstance.