The number of hybrid and remote employees has greatly increased since the onset of the pandemic. As of February 2022, 39% of remote-capable employees were fully remote, 42% were hybrid and only 19% were fully on-site, according to Gallup.
At the same time, many remote employees have relocated to different states, either temporarily or permanently.
Having a policy that allows employees to work from anywhere can help employers attract and retain top talent, but it also can affect employers’ own tax filing obligations. A system for tracking where employees are performing their work is crucial for complying with the obligations that arise from having employees who work remotely. What follows is an overview of some of the state and local tax implications employers should know about.
Where Do You Start?
The first consideration an employer should consider is whether the employee’s location will affect the employer’s tax nexus and overall tax obligations. As with all state and local tax obligations, employers must first recognize that each state and local jurisdiction has its own laws and rules that determine whether the employer has established tax nexus and what obligations flow from that.
What Is Nexus?
Nexus means a taxpayer has sufficient contacts with a jurisdiction to subject the taxpayer to tax obligations in that jurisdiction. Most states have two types of nexus tests: physical and economic.
Physical presence nexus laws require some form of physical presence within the jurisdiction before taxes can be imposed. The presence of employees within a state is one of the factors that can establish physical presence nexus. In some jurisdictions, the presence of employees will only establish nexus if it is a “substantial” presence defined by meeting certain payroll thresholds.
Economic nexus has in recent years become the more common test. Nearly all states have established economic thresholds based on annual revenue from sales to customers within (or deliveries to) the state, the annual number of transactions with customers in the state, and/or service income sourced to the state. Taxpayers who meet the thresholds have nexus in the state.
Nexus rules can also apply at the city level, subjecting taxpayers to, for example, the City of Seattle business gross receipts tax or New York City business corporation tax. Again, the city-level nexus can be established by physical presence or economic presence depending on the laws of the specific jurisdiction.
So having employees in a state might establish nexus for an employer that did not previously have nexus in the state. But for many employers, the nexus may already have been established by the company’s own economic activities related to the state, even if not physically present in the state.
What Are the Consequences of Establishing Nexus?
Once nexus is established, the taxpayer must register with the state and/or city and comply with all tax obligations. Depending on the jurisdiction, the tax obligations may include corporate income tax, gross receipts tax, franchise tax, sales and use tax (whether payment obligations as a consumer or collection obligations as a retail seller), other excise taxes, and employer/payroll withholding and taxes. Failure to register with the state and/or city and comply with all tax obligations may result in penalties. If the employer realizes that it may have had nexus for past periods, it should carefully consider whether participating in the jurisdiction’s voluntary disclosure program would be beneficial.
What Are the Considerations for Employment/Payroll Taxes?
In addition to nexus rules, employers should review employment tax requirements when remote employees live in jurisdictions where the employer does not currently have filing obligations. Generally, states require an employer to withhold income taxes from their employees’ wages. Where an employee has connections with more than one state, the employer must carefully determine which state or states can impose withholding obligations based on where the employee is domiciled or qualifies as a resident and, often for nonresidents, where the employee’s income is sourced. The laws governing the specific state must be examined to make this determination. Unfortunately, even a state where the employee spends less than half the year might qualify as the employee’s domicile with full withholding rights.
States also have requirements related to unemployment and workers’ compensation insurance. Employers should review their obligations in each jurisdiction where a remote employee is located to ensure compliance.
Some cities also have payroll taxes and other obligations based on companies whose employees perform work in that jurisdiction. For example, the City of Seattle recently started collecting a payroll expense tax that requires employers to know whether each employee was working in the city during the year.
Be Prepared
For all these obligations, it is important to have a system that tracks where employees perform their work. It also is vital to retain contemporaneous documentation just in case the tax jurisdiction conducts an audit in the future.
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