EB Buzz: Tax Issues with Remote Workers
The COVID-19 pandemic has caused an explosion of remote work arrangements. One HR executive recently commented, "I don't even know where my employees are physically located anymore. They only contact me when they want a printer for their home office or want the company to pay for their home WIFI." As you can imagine, there is a myriad of tax issues from employees working remotely.
1. Potential Application of Section 139 to Home Office Expenses
Section 139 provides that "qualified disaster relief payments" are payments to an individual for personal, family, living, or funeral expenses resulting from a "qualified disaster," which could include expenses such as childcare, medical expenses, or increased home office expenses. Because the COVID-19 pandemic was designated as a national emergency, payments from an employer to an employee can now qualify. Expenses associated with setting up or maintaining a home office can qualify for income exclusion under § 139 such as enhanced internet connections, computer monitors, laptops, printers, office supplies, etc. (even if such expenses would not otherwise satisfy the home office deduction requirements).
2. Application of the Working Condition Fringe Exception
Working condition fringes are generally defined under § 132(d) as any property or services provided by an employer that, if paid by the employee, would be deductible as a trade or business expense under IRC Section 162. The value of a working condition fringe (WCF) benefit is excludable from an employee's income. To qualify as a working condition fringe, the benefit received by the employee must be related to the employee's duties for the employer. Provided the employee substantiates the expense or the employer provides the item in-kind, the WCF exclusion will generally apply to most items that an employee needs to work from home. Employers have long taken the position that the WCF exclusion should apply to laptops and peripheral equipment.
For years, the Internal Revenue Service (IRS) routinely audited the tax treatment of employer-provided cell phones because employees did not comply with the stringent recordkeeping requirements applicable to "listed property." The IRS conceded this issue in Notice 2011-72, which states that the IRS will treat the employee's use of employer-provided cell phones for reasons related to the employer's trade or business as a working condition fringe benefit and treat any personal use as an excludable de minimis fringe benefit, provided the cell phone usage is provided primarily for noncompensatory business reasons. Although the Tax Cuts Jobs and Acts of 2017 (TCJA) removed computers and peripherals like printers, monitors, fax machines, etc., from the definition of listed property, it is unclear whether this should apply to home internet/WIFI or if Notice 2011-72 should be expanded to include home internet. Therefore, it is unclear whether employer-paid internet should be treated as taxable perk or if employees must maintain stringent records to exclude a portion of employer-paid home internet service.
3. Income Tax Withholding from Remote Workers
As a general rule, unless a state has a reciprocity agreement with a neighboring state, most states require employers to withhold income taxes based on the location of where the work is physically performed. For example, if a resident of Nevada works in California for a California employer, the employer must withhold California income taxes from the employee's wages. Further complicating the issue, most states also require employers with operations within their state to withhold on state income taxes from the wages of residents for services in other states if that state has no income tax (or even a lower income tax withholding rate). Complying with these state income taxes has long been a daunting task for employers, particularly those with a mobile workforce.
Under the so-called "convenience of the employer rule," to determine whether New York will tax the wages of a telecommuter, if the employee's principal office is located in New York, then compensation earned while working at home in another state will be treated as if earned in New York, if the employee is working from home for her own convenience and not the employer's necessity.
Several states have released COVID-19 guidance that they won't require employers to withhold income taxed on employees' wages based on temporary work within the state triggered by a COVID-19 quarantine/stay-at-home order. Many other states have not relaxed these rules, however. The New York Department of Revenue (DOR) has not released any guidance on the impact of COVID-19 on New York's application of "convenience of the employer" test on taxing nonresidents that work from their homes for personal reasons. The New York Senate proposed legislation that would relax the requirement during the stay-at-home order (3/27/20 – 9/7/20), but there has been no action on that bill.
4. State Nexus Concerns for Corporate Income Tax
In Complete Auto Transit, Inc. v. Brady, the Supreme Court set out a four-pronged test a state corporate income tax must satisfy under the Commerce Clause, which included the nexus test. Under the nexus prong, a state violates the commerce clause if there is no sufficient nexus between the activity and the state imposing the tax. States have different interpretations of what constitutes a sufficient state nexus for purposes of imposing a corporate income tax.
In Telebright Corporation v. Director (New Jersey Division of Taxation), decided in 2012, an employee for Telebright Corporation moved to New Jersey and worked remotely for Telebright after relocating. She developed and wrote software code from a laptop in New Jersey, which was then used to create products provided to the company's customers. She was supervised and reported to a project manager in Boston, with whom she communicated by email and phone. Telebright had no locations in New Jersey. The court affirmed the New Jersey Tax Court's opinion that a "foreign corporation that regularly and consistently permits one of its employees to telecommute full-time from her New Jersey residence is doing business in New Jersey [and] is subject to the New Jersey Corporation Business Tax Act."
In a survey conducted in 2020 before the "shelter-in-place" and "work from home" policies were enacted, 36 states and Washington, DC stated that having "one to six employees telecommuting from home doing non-solicitation activities" was enough to create nexus for corporate income tax. Only Indiana and Mississippi explicitly responded "No." The responses were similar for questions asking about "one employee telecommuting from home doing back office functions" (33 states and DC) and "one employee telecommuting from home doing product development functions" (34 states and DC).
At least 20 states have indicated that telecommuting during COVID-19 will not create nexus if the employer previously had no connection to the state. Other states have not yet provided any guidance on how they intend to proceed during COVID-19.
Should I be concerned with having remote workers?
Remote workers are here to stay and there are ways that employers can assist employees with setting up their home offices on a tax-friendly basis. However, there are certainly state income tax withholding and corporate tax nexus pitfalls that employers need to recognize.
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