Are you struggling to understand how interstate tax works? With COVID-19 establishing remote work as the new normal, it has become a common practice among employees to move to low-tax states and telecommute with their employers. Unfortunately, these employees may still have to pay tax on the basis of their previous residence. The same applies to businesses shifting to states with low taxes to reduce their tax burden. In this case, they need to watch out for taxes applying to cross-border business operations.
The following are interstate tax issues and how they impact employees and businesses.
The Current Situation
According to the Society for Human Resource Management (SHRM), work-from-home models have created significant tax compliance issues for employers. Since the beginning of the pandemic, 28% of employees in the US have been working outside their resident state or country in order to cut back on expenses, reduce taxes, and avoid commuting costs.
However, despite moving to a different state for remote work, many of these individuals are still employed by the same company. As a result, they may still be liable to pay non-resident taxes in certain states.
There are seven states which have some form of convenience of employer rules, they are Massachusetts, New York, Arkansas, Connecticut, Delaware, Nebraska and Pennsylvania. The convenience rules allow a state to continue taxing out-of-state employees who are no longer commuting to the office. Under New York’s ‘convenience of employer’ rule, if you are employed by a New York company, you will be considered as an individual working in New York no matter where your home office is. An exception to this rule is if your company also has an office in the city or state where you relocated. Many states have reciprocal agreements with neighboring states where employees receive a tax credit for the double taxation when they pay income taxes to more than one state on the same income.
What About California?
Employers must understand and comply with the payroll tax obligations for out-of-state workers. They must be aware of each state’s laws regarding taxation of remote work when an employee works in a state other than where their worksite is located, or a state other than their primary residence.
California employers are required to withhold income tax when a California resident performs services that are subject to state income tax withholding laws of both California and another state. However, states without a convenience of employer rule do not double tax the same income. California complies with multistate tax obligations by making the withholding required by the other jurisdiction, and for California, making the California withholding for the amount only that portion that exceeds the withholding amount for the other jurisdiction. If the other jurisdiction’s withholding amount is equal to, or greater than, the California withholding amount, California will not require additional withholding.
During the COVID-19 pandemic, the California State Franchise Tax Board waived the business nexus during the emergency if resident employees had to work temporarily from home due to the pandemic. However, employers need to verify whether any similar waiver is in place for the “home” state of its employees when determining state income tax withholding.
Without any other reciprocity agreement that would allow residents to pay tax only based on where they live, and not where they work, employees may be required to file multiple returns to ensure proper taxation. California does not have reciprocal tax agreements with other states.
Before the Pandemic
It is important to note that even before the pandemic, it was a fairly common practice among employees and businesses to move to low-tax states. These changes became particularly prominent after the Tax Cuts and Jobs Act that was passed in 2017. The Act brought an onslaught of new rules. Among these, it also put a limit of $10,000 on state and local tax deductions. Due to the cap, multiple employees and businesses were interested in moving to a low-tax state. The pandemic appears to have spurred that decision for many employees who are moving to their vacation homes to work.
Wrapping It Up
Interstate tax can impact the earnings of employees and businesses alike. If you have moved to a low-tax state during the pandemic or have set up a bona fide business office in a different state, then you need to ensure you are still complying with tax rules. In the case of employees, even if you have your home office in a different state, you may still need to file tax returns under the ‘convenience of employer’ rule. Employers need to determine if they are in compliance with the tax laws their home state and in each state they have an office or an employee.
If you need help figuring out how these taxes apply to your business, contact the team at Windes. We specialize in business accounting solutions and can help you determine which taxes you must pay to ensure tax compliance.
For questions or more information about this article, please contact our tax professionals at email@example.com or toll free at 844.4WINDES (844.494.6337).