The COVID-19 pandemic forced many employees to participate in a global experiment on the pros and cons of remote work. As a result, it’s here to stay for many businesses. A remote workforce offers many benefits, for employer and employees alike. But it may also lead to some tax surprises, especially if workers cross state lines.
Employees: How to avoid double taxation
It wasn’t unusual, during the early days of the pandemic, for employees to work remotely from another state. Perhaps they wanted to take advantage of a vacation home during lockdown or simply wanted to get out of the city for a while. For some businesses, however, remote work has become a permanent arrangement, allowing employees to live and work further away from the brick-and-mortar office.
If you live in one state and work remotely for an employer in another state, familiarize yourself with the tax laws in both states and determine how they may affect you. For example, you may need to file income tax returns in both states, which may result in increased — or even double — taxation.
Here’s the problem: States generally have the power to tax the income of people who are domiciled there as well as people who reside there. Domicile is a state of mind, and is often based on a person’s intent to make a location his or her “true, fixed permanent home.” Residency is based on physical presence in a state for a certain amount of time (typically, 183 days per year).
It’s possible to be domiciled in one state and a resident of another. For example, Dan has a home in State A, where his job is located, and a vacation home in State B. His employer allows employees to work remotely, so Dan now spends more than 200 days per year living and working in State B. State A considers Dan to be domiciled there, but State B views him as a resident, so he’s subject to taxes in both states on the same income. He may avoid double taxation if one or both states provide credits for tax paid to other states. But his tax bill may still increase if, for example, State B’s income tax rate is significantly higher than State A’s rate.
One way for employees to avoid double taxation is to ensure that they’re both residents and domiciliaries of the state from which they’re working remotely. Going back to the example, if Dan sells his home in State A and takes other steps to cut ties with State A and establish roots in State B, he may avoid taxation by State A. However, this may not work if State A is one of the handful of states that have enacted “convenience of the employer” laws. Under these laws, a state can tax an out-of-state employee’s income from a source within the state, if the employee works remotely for his or her own convenience, not the employer’s. In other words, State A can impose its income tax on Dan by demonstrating that he’s working from State B for personal reasons rather than because it’s a job requirement.
Employers: Why multistate tax issues matter
From an employer’s perspective, allowing employees to work remotely may create obligations to withhold and remit income and payroll taxes in several states. Plus, having employees in other states may be sufficient to establish nexus with those states, potentially triggering liability for their income, franchise, gross receipts, or sales and use tax. In addition to the expense of tax reporting in multiple states, this may increase an employer’s overall tax liability.
Typically, states determine the portion of a business’s income subject to their taxes based on an apportionment formula tied to the percentage of the business’s sales, property and payroll attributable to that state. Most states’ formulas consider either all three factors or a single sales factor. Whether apportionment increases or decreases a business’s tax liability depends on whether its income is apportioned to a state with higher or lower tax rates than its home state.
Exercise remote control
If you’re a remote worker or own a business that employs remote workers, be sure you understand the tax implications. In some cases, you may be able to take steps to minimize multistate tax obligations. But even if you can’t, it’s important to know what to expect.
Can remote workers deduct their business expenses?
Generally speaking, employees can’t deduct unreimbursed job-related expenses under current tax law. Prior to the Tax Cuts and Jobs Act (TCJA), employees could claim certain costs as miscellaneous itemized deductions, which are deductible to the extent they exceed 2% of adjusted gross income. But the TCJA eliminated those deductions for 2018 through 2025.
Remote workers generally aren’t eligible for the home office deduction either. That deduction is generally limited to self-employed business owners. Pre-TCJA, employees could claim the deduction if, among other things, they worked at home “for the convenience of the employer.” It may be difficult for remote workers to demonstrate that they’re working at home for the employer’s convenience. But in any event, the TCJA also eliminated that provision for 2018 through 2025.
The most tax-efficient option is for the employer to reimburse remote workers for their business expenses according to an “accountable plan” that requires employees to substantiate their expenses and meets certain other requirements. Properly reimbursed expenses are deductible by the employer and excludable from the employee’s income.