During the COVID-19 pandemic, many employers shut down their regular workplaces, either partially or wholly, as a safety precaution and instructed their employees to work from home. While some employees have returned to work, many are still working from home. Some employers have found that using remote workers is a sound strategy going forward. As a result, the state in which an employee lives may not necessarily be the same as the state where he or she works. How does this affect state income tax withholding?
There's no universal tax blueprint. The laws can vary widely from state-to-state. Recently, the U.S. Supreme Court refused to hear a case on this issue that could have provided more clarification. (See "Top Court Just Says No to Remote Taxation Case" at the bottom of this page.) In addition, some jurisdictions have reacted to the pandemic by imposing new rules that are still evolving.
Important: State tax withholding is not an issue in the nine states where there's no state income tax on wages. These states are Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming.
Here's an overview of how various other states are handling this issue. Reminder: These rules are subject to change.
The California Franchise Tax Board has posted answers to frequently asked questions (FAQs) about withholding on wages to teleworking employees. It refers to a stay-at-home order implemented by Executive Order N-33-20 on March 19, 2020.
According to the FAQs, the order will be weighed to determine whether someone is working in California for a "temporary" or "transitory" purpose. Therefore, a nonresident who relocates to California temporarily while working for a California employer or an out-of-state employer will have California source income during the period.
The New York Department of Taxation and Finance has posted FAQs regarding state and local income tax liability due to the pandemic. This publication offers pertinent information on who's considered to be a resident or nonresident in New York. It also provides guidance for nonresidents who have a primary office in the state but are telecommuting from outside the state.
According to the FAQs, unless an employer has a "bona fide" office in the nonresident's state, days working from home will be viewed as days worked in New York. Therefore, workers in this situation must file and pay New York income taxes.
The Illinois Department of Revenue (IDOR) issued an informational bulletin clarifying that employees currently working from home in Illinois due to the pandemic may now be subject to Illinois withholding requirements. Essentially, employee compensation is subject to Illinois withholding if an employee has performed normal work duties in Illinois for more than 30 working days. The employer may be required to register with IDOR and withhold Illinois income tax.
Out-of-state employers from reciprocal states — including Iowa, Kentucky, Michigan and Wisconsin — aren't affected by the guidance. IDOR has said it will waive penalties and interest for out-of-state employers who don't withhold Illinois income taxes when the sole reason the employee is working from home is due to the COVID-19 crisis.
There's no COVID-19-specific guidance for Michigan. Generally, withholding is required on wages of nonresidents performing work in the state. But residents of Illinois, Indiana, Kentucky, Minnesota, Ohio and Wisconsin may file a form with their employers to be exempt from Michigan withholding. Withholding is required for wages of Michigan residents working out-of-state.
FAQs posted on the Michigan Department of Treasury website on April 1, 2020, confirmed this rule: If an employer is located in a Michigan city that imposes a city income tax, the wages of a nonresident who telecommutes from home isn't subject to tax on wages earned while telecommuting from a location outside the city. Employers are responsible for providing employees with a letter stating the dates that employees were directed to work from home.
Many of the provisions relating to state income tax withholding rules due to the pandemic are temporary. Examples include:
Pennsylvania. According to FAQs from the Pennsylvania Department of Revenue, if an employee is working from home temporarily due to the COVID-19 pandemic, this isn't treated as a change to the sourcing of the employee's compensation. However, the guidance expired on June 30, 2021.
New Jersey. This state's rules specify that income is sourced where the service or employment is performed, based on a day's method of allocation. But the New Jersey Division of Taxation has advised that its policies, procedures and provisions, which were revised or relaxed due to the pandemic, will now be affected by the rescission of the public health emergency. These issues are currently being reviewed and guidance will be provided to the public soon.
Maryland. The Maryland Comptroller's office has advised that it won't use the temporary nature of work to impose business nexus, alter the sourcing of business income or impose additional withholding requirements on the employer. This directive was renewed on June 15, 2021.
Massachusetts. All compensation received for services performed by a nonresident who, immediately prior to the Massachusetts COVID-19 state of emergency, was an employee working in Massachusetts, and who's working from a location outside Massachusetts due to a pandemic-related circumstance will continue to be treated as Massachusetts source income. Such income will be subject to income tax and withholding. These rules are scheduled to expire on September 13, 2021.
Missouri. Effective January 21, 2021, the Missouri Department of Revenue issued an emergency rule allowing employers to elect to withhold and remit tax based on their primary work location when their employees were working from a temporary work location due to the pandemic.
This article only covers rules that apply in some states. As workers telecommute during the pandemic and beyond, state tax withholding can be a confusing issue for employees and employers alike. The rules are still evolving and can change quickly in some cases. Contact your tax and payroll advisors to stay updated on your situation.
New Hampshire recently filed a case with the U.S. Supreme Court, claiming that its citizens' constitutional rights were being violated by Massachusetts' policy of continuing to withhold income tax on employees working remotely due to the pandemic. The policy effectively imposes taxes within another jurisdiction despite state sovereignty. New Hampshire has argued that this violates both the commerce clause and the due process clause of the U.S. Constitution.
The Biden administration filed an amicus curiae brief. It argues that the matter wasn't within the Court's original jurisdiction and a lower course should hear the case at the state level.
The Court refused to hear the case, siding with the Biden administration. The denial states that the case doesn't fall within its original jurisdiction because it concerns withholding of tax from individual private parties, albeit en masse. The Court also asserts that New Hampshire (as a state) doesn't have the standing required to file a case based on violations of either the commerce clause or the due process clause.
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