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Remote Working Implicates State Payroll Tax, Corporate Income/Franchise Tax Nexus Concerns

May 01, 2020

Employers should be aware that remote working arrangements during the coronavirus (COVID-19) pandemic may inadvertently trigger state payroll tax registration and filing requirements for their businesses, and possibly trigger corporate income/franchise tax “nexus” with another state, subjecting the business to that state’s tax regime.

To prevent the spread of COVID-19, several state and local governments have issued stay-at-home orders, effectively mandating remote work for employees of so-called nonessential businesses. Even if not mandated, many employers have opted to allow their employees to work remotely. Employers should be aware that these remote working conditions may inadvertently trigger state payroll tax registration and filing requirements for their business. These remote working conditions may also trigger corporate income/franchise tax “nexus” with a state with which the business did not have nexus before, and thus subject the business to that state’s tax regime.

The thresholds requiring state payroll tax registration and filing requirements vary significantly among states. Many states have specific wage or day thresholds that an employee must meet before an employer is required to withhold state tax. Several other states require employers to start withholding on an employee’s wages the first day that the employee works in the state for the employer. Additionally, employers have to consider reciprocal agreements among various states and unusual state-specific rules such as the “convenience of employer” rule.

For corporate income/franchise tax purposes, the nexus determination hinges on whether a business has sufficient minimum contacts with a particular state for the state to constitutionally subject the business to the state’s tax regime. Under general nexus principles, an employee working in a state in which their employer does not otherwise operate can trigger nexus with that state, and therefore expose the employer to the state’s tax regime. As a result, most employers are cautious about their business decisions to expand to or locate their employees in other states.

Provided that the above-described remote working conditions are put in place as temporary measures for the health and safety of employees and society at large, the ordinary application of laws and policies concerning wage tax withholding and nexus will, in many cases, lead to unfair results.

Potential Avenues of Relief

Federal Action

The state payroll tax filing requirements triggered by remote working arrangements as a result of COVID-19 may be resolved through coordinated action at the federal level between the US Department of the Treasury, the Internal Revenue Service (IRS), and affected state and local tax authorities, or possibly through Congress. Federal legislation aimed at addressing similar workforce mobility issues has been introduced before, albeit not with a global health crisis as the backdrop. Most recently, Senate Bill 604, the Mobile Workforce State Income Tax Simplification Act of 2019, was introduced but never enacted.

Recognizing the multitude of tax issues created by the COVID-19 pandemic, we have recently submitted a comprehensive list of relief recommendations to the IRS Office of Chief Counsel. In particular, we highlighted that as a growing number of employees are being required or encouraged to work remotely, state and local tax issues arise when teleworking employees do so from a tax jurisdiction different from their primary office tax jurisdiction, and we have urged for federal-level coordinated action to provide relief to employers. As of the date of this LawFlash, Congress has not passed any legislation dealing with this issue.

State Action

In the absence of federal guidance, a growing number of states have formally published guidance on their approach to payroll tax obligations and corporate income/franchise tax nexus issues created by remote working arrangements under COVID-19. As of the date of the publication of this LawFlash, 11 states have released at least some guidance on these issues.[1] For example, the New Jersey Division of Taxation has stated that it is temporarily waiving the impact of its nexus laws as applied to employees “working from home solely as a result of closures due to the coronavirus outbreak and/or the employer’s social distancing policy.” Similarly, Mississippi has announced that it will not use changes in an employees’ temporary work location due to COVID-19 to impose nexus.

While we have yet to see whether even more states will provide similar relief through published guidance, tax officials in several states have informally acknowledged the nexus issues faced by employers. For example, tax officials from the District of Columbia, Pennsylvania, and Oregon have generally stated that they will consider the impact of COVID-19 in nexus determinations. We will continue to monitor these developments and provide updates as new information becomes available.

COVID-19 and the Convenience of the Employer Test

Employers that operate in Connecticut, Delaware, Nebraska, New York, and Pennsylvania should also note the unique challenge presented by the “convenience of the employer” test in the current environment. While most states source employee wages for payroll withholding purposes to the state where the employee performs the services, these five states have enacted “convenience of the employer” laws.

With some variations across the states, compensation earned by a nonresident employee is allocated to the location of the assigned office of the employee, unless the work the nonresident performs is work that, of necessity and not convenience, obligates the employee to work from a location other than the assigned office. Thus, the wages of an employee may result in a tax withholding requirement in the office state, regardless of whether the employee is working from home in another state.

Generally, states that impose the “convenience of the employer” test apply strict definitions of what constitutes working from home for the employer’s convenience for payroll withholding purposes. Absent specific guidance, it is uncertain (1) if working remotely from home due to COVID-19 is for the employer’s convenience, (2) if there is an exemption with respect to COVID-19, or (3) if the states would distinguish between voluntary work-from-home initiatives versus mandatory orders. To illustrate past state action in light of an emergency, New York offered nonresident income tax exemptions for Hurricane Sandy, but did not concede that work outside of New York due to Hurricane Sandy was for the employer's convenience.

As a final note, in states such as New York, employers may want to evaluate whether they are an “essential business” allowed to operate as usual under the COVID-19 remote working mandates. If so, it is possible that the employer may continue to rely on the “convenience of the employer” rule as normal.

To date, no guidance on the interaction between COVID-19 and the convenience of the employer rule has been released. We will continue to monitor these developments and update our clients and readers. Morgan Lewis has prepared a chart summarizing the state and local tax responses to COVID-19 issued by various jurisdictions. This chart will be updated regularly.

See the chart on state and local tax responses >>

Coronavirus COVID-19 Task Force

We have formed a multidisciplinary Coronavirus COVID-19 Task Force to help guide you through the broad scope of legal issues brought on by this public health challenge. We also have launched a resource page to help keep you on top of developments as they unfold. If you would like to receive a daily digest of all new updates to the page, please subscribe now to receive our COVID-19 alerts.

Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Chicago
Adam P. Beckerink
Matthew S. Mock
Laura Grace Mezher
Colleen M. Redden

New York
Mary B. Hevener
Cosimo A. Zavaglia
Ester Lee

Philadelphia
Justin D. Cupples

Washington, DC
Steven P. Johnson


[1] Indiana, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, New Jersey, North Dakota, Ohio, Pennsylvania, and Washington, DC.