The general rule of thumb for nonresidents has long been that nonresidents can only be taxed by a state on income earned in that state (i.e., source income). Seems simple enough, right? As every state tax professional knows, nothing is ever simple when it comes to taxes. Notably, states—and localities—have separate determinations as to when income is earned in their jurisdiction.

The recent pandemic highlighted many of the issues for determining when income is earned in a state as employees were working away from the office. For example, the oft-challenged pandemic legislation in Ohio that allowed localities to treat work performed outside that locality as if that work was performed in that locality. See, Ohio H.B 197; see also Morsy v. Dumas, Case No. CV 21 946057 (Oh. Ct. Comm. Pleas, Sept. 26, 2022); Shaad v. Adler, Case No. 2022-0316 (Oh. Sup. Ct. Decision pending).

Courts in Missouri also recently grappled with this issue of determining where services were rendered by nonresidents for purposes of the St. Louis Earned Income Tax. Boles v. City of St. Louis, Case No. 2122-CC00713 (Mo. Cir. Ct., Jan. 19, 2023). And those examples don’t even begin to cover the myriad of sourcing issues created by states that have the Convenience of the Employer rule (e.g., New York, Pennsylvania, and others). Thus, the recent decision in Baty v. Alabama Department of Revenue was refreshing in its simplicity. Docket No. 22-298-LP (Ala. Tax Trib., May 19, 2023).

In Baty, the taxpayer was a Florida resident who worked for an Alabama company. The taxpayer alleged that because he worked from home in Florida for a portion of each day that his income was not Alabama-sourced. The Alabama Tax Tribunal held that the taxpayer performed services in Alabama and, therefore, is subject to tax on his Alabama-sourced income. However, Alabama law is clear: Income is sourced to the state if the work is physically performed in the state (with limited exceptions). Ala. Admin. Code r. 810-3-14-.05. Thus, the employee would only be subject to Alabama taxes on the portion of his wages related to work physically performed in Alabama.

Given the difficulties in determining where work is performed or rendered, states that have a more bright-line standard of sourcing income to the location where the work was physically performed eliminate much of the confusion and difficulties that surround vague or ill-defined statutes. A little bit of clarity goes a long way.

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