Tax Director Gretchen Ockman, CPA, recently authored an article for New Orleans CityBusiness on the tax implications of offering a remote work option. Since the start of the pandemic, it has become more commonplace for businesses to allow employees to work from home. However, when a worker’s home is in a different state than the primary business location, it triggers tax consequences that a business owner will need to understand. Read on for the full article.
Tax Implications of Remote Work: Is Your Business Prepared?
by Gretchen Ockman, CPA
Although the financial stressors of COVID-19 will likely reverberate for years to come, many business leaders have embraced the opportunity to find new and creative ways to get work done. Along with more flexible work schedules and a growing reliance on the gig economy, many companies have incorporated a work-from-home option for their employees. If business leaders believe the company and its employees will benefit from remote work, they need to understand the tax consequences of that decision, particularly when some or all employees live in a different state than the primary business location.
When a business allows employees to work remotely, payroll taxes should be their first concern, and here’s why: unless the two states have a reciprocal agreement, payroll is sourced to the state where the work is performed. This will have a few different consequences:
- The business will need to establish payroll tax accounts with those states’ Departments of Revenue.
- Employees may need to select state-specific withholding allowances. Many states have their own versions of IRS Form W-4, Employee’s Withholding Certificate.
- The business will need to begin withholding the appropriate state’s income taxes from employees’ paychecks and pay into those states’ unemployment funds, if required.
- The business will need to warn employees that their state taxes are changing. This notification will give employees time to prepare for their own filing responsibilities come April 15th.
But payroll tax isn’t the only concern businesses should have when they allow employees to work remotely. Income tax and sales tax filing requirements may also change. In most states, the physical presence of an employee – even just temporarily – is enough of a connection to generate nexus.
Nexus is the minimum connection a business must have with a state before the jurisdiction can enforce its tax laws. If income tax nexus is triggered, businesses will need to begin filing income tax returns in that state. The most difficult aspect of income tax compliance isn’t establishing a tax account or even filing the tax return itself; it’s apportioning income.
Multistate businesses are required to allocate and apportion their business income to the states in which they operate. Business leaders who have never filed in more than one state may be surprised at how much extra time this calculation can take. Some business income – like interest and dividends – is easy to allocate, but other income is allocated using a more complex apportionment method established by the jurisdiction. These apportionment methods vary from state to state, but a common approach assigns income based on where the business’s property, payroll, and sales are located.
Apportionment calculations can be tricky, and even businesses that have experience apportioning income will need to tweak their calculations to add another state into the mix. It’s imperative that business leaders set aside time to gather information and discuss the apportionment methodology with their accountant.
An employee’s presence within a state may also establish nexus for sales tax purposes. Once sales tax nexus is established, businesses must start collecting and remitting sales tax for all taxable sales completed within the state or delivered to that state’s residents.
Many state governments are overhauling their sales tax laws in response to the June 2018 U.S. Supreme Court case South Dakota v. Wayfair. The Court determined that physical presence is no longer required for states to impose sales tax filing responsibilities on remote businesses. Because this ruling lowered the bar to establishing nexus, many states increased their sales tax collection efforts. Businesses who fail to comply with sales tax laws face steep penalties and interest in addition to back taxes. This is a fluid situation and it is imperative that businesses stay abreast of changes.
There may be a bit of good news, though. Some states have elected not to impose new filing responsibilities on businesses if nexus is established solely from employees working remotely due to the coronavirus pandemic. Iowa, for example, says, “the Department will not consider the presence of one or more employees working remotely from within Iowa solely due to the COVID-19 pandemic, by itself, sufficient business activity within the state to establish Iowa corporate income tax nexus.” But other states – like Texas, Louisiana, and Kentucky – made no such concessions. Business leaders should ask their accountants about tax relief that may be available during the COVID-19 National Emergency.
Having remote workers can affect more than just taxes. Businesses have other operational concerns to consider.
- Businesses should document where their employees are working each day. Even if current tax laws appear to waive new filing responsibilities for remote workers, it’s good practice to track this information.
- Employees may not be covered by worker’s compensation coverage when they work from home. Businesses will need to look at their policies and consider riders that protect their employees wherever they are working.
- Data privacy, improved network capabilities, and secure communication channels will be imperative if remote work is to continue long term.
- If businesses do establish nexus in a new state, they should research how to register to do business within that state and be prepared to pay annual registration fees.
Operational changes, such as remote workforce options, brought about by the pandemic are most certainly here to stay and business leaders need to understand the ramifications of these flexible arrangements. A qualified CPA firm will be an important resource for guidance in this area.
Gretchen Ockman, CPA, is a director of tax services at LaPorte CPAs & Business Advisors. She provides tax planning, compliance and consulting services primarily to closely-held companies and their owners. She works with companies with multistate operations and has a wide range of industry experience including automotive, construction, and professional services.