Technology companies have been at the forefront of accommodating telecommuting employees who wish to work from home for lifestyle and other reasons. Companies may want to re-think this employee policy because of the potential tax burdens and economic consequences. A ground-breaking New Jersey case, Telebright Corporation, Inc. v. New Jersey Division of Taxation (2012), creates tax consequences, where none previously existed, for an employer who allows its software developers to telecommute from another state and write code that is included in software that the company sells to customers.
What does this mean for tech companies? It means that states are stretching the limits of traditional taxing principles in order to collect its share of tax revenues. It means that tech companies must now be judicious when permitting telecommuting arrangements for their employees, or face increased state tax liabilities and compliance. It also means that tech companies should seek counsel from a tax advisor to ensure that the company’s business footprint does not trigger increased state tax issues.
Technology companies in growth-mode tightly manage their business and tax footprint. It is important to ensure there are no unforeseen tax liabilities if the tech company wants to be acquired or obtain another round of VC financing. Buyers of tech companies have become increasingly aware of state tax liabilities during the due diligence process and have focused on the company’s management of state tax compliance and potential exposure. In some instances, these unforeseen liabilities have derailed an acquisition or significantly reduced the expected purchase price of the tech target company. The Telebright case has added a new wrinkle for tech companies to manage.
A state can tax the revenues of a business based on that company’s contacts with the state. These principles are rooted in the U.S. Constitution, federal and state case law, and state statutory schemes. As business practices have changed over the past several decades (i.e., use of mail order catalogues, the Internet) and businesses’ use of their employees to generate revenues have become more sophisticated, courts have evolved and applied state taxing principles to these new business practices.
It has been axiomatic for decades that a company sales employee living and working in a state subjected the company’s business income to the state’s taxing regime. By having a sales employee in that state, the company was availing itself of the state’s marketplace. Courts reasoned that the purpose of the sales employee was to generate sales for the company’s business, so it was reasonable for the state to tax its share of corporate revenues.
To illustrate, assume iTech Company is headquartered in California and develops hardware for sale to businesses. iTech Company has only one sales person who lives in Massachusetts and whose job responsibility is to sell iTech hardware to businesses located in that state. Traditional state tax principles would permit the state of Massachusetts to tax a proportionate share of the iTech total company revenues. iTech would have to file a tax return in Massachusetts and pay tax on the sales of hardware that occurred in Massachusetts. iTech would not have to file tax returns in other states since it had no sales employees or any other presence in any other state.
In contrast, “back office” telecommuting employees who did not generate revenue for their company by residing in their home state would not expose their company to the state’s taxing regime. This telecommuting situation was treated differently by states because the back office employee was not actively engaging in a state’s marketplace on behalf of its corporation to generate sales.
The Telebright case has changed the significance of a “back office” telecommuting employee, at least in New Jersey, and may force tech companies to limit telecommuting arrangements for employees who write software code. Other states are sure to follow New Jersey’s lead.
Telebright involved a Maryland company that allowed an employee to work from her new home in New Jersey after her husband’s job forced her to relocate there. The employee wrote code for an application that Telebright sold to its customers. Telebright decided that the employee did not need to come to the office to perform her job duties and so they provided her with a laptop and allowed her to telecommute from New Jersey.
The New Jersey court concluded that the Telebright employee produced computer code for her company in New Jersey while she enjoyed all of the legal protections that New Jersey provided to its residents. The court concluded that the full-time New Jersey telecommuting employee was, by writing software code for the application, creating a portion of the product that Telebright was selling to customers and that this was sufficient business activity for New Jersey to tax a portion of Telebright’s corporate revenues.
This decision extends traditional state tax principles. Telecommuting has benefits for both the company and its employees. A tech company that allows telecommuting frequently does so for the benefit of the employee – not because of a strategic business reason. Yet, the Telebright decision now establishes precedent to subject a company to additional corporate tax if it has an employee telecommuting from a state where the company does not already have business nexus. Tech companies would be wise to review existing telecommuting arrangements and carefully think through future arrangements in order to avoid unforeseen tax liabilities and burdensome compliance.