There have always been some people who worked remotely for companies in other states, but that number exploded during COVID-19. First, many employees started working at home – often because they were required to due to quarantine restrictions and closed offices — and some of them happened to live in different states from their jobs. Second, several employees, realizing that they could live anywhere and still do their jobs, took the opportunity to move to other states, either to be close to family or to enjoy a lower cost of living or better quality of life, and are now working remotely from another state. Now, although the pandemic is thankfully on a downward trend, companies have learned to adapt, and the employees are continuing working in another state.
In some cases, employees may have moved to states without income tax in the hopes of saving money. But depending on whether the employees took remote work tax implications into account, they may be getting an unpleasant surprise around now. Here’s why.
What Happens When You Live in One State and Work in Another
When you’re employed full-time, your company typically withholds state taxes from your salary throughout the year. That withholding is based on where the company thinks you’re working, as well as the company’s policy for how it handles state tax withholding for remote employees.
If you have become a permanent remote worker, and your company doesn’t know you’re physically working in a different state, or if it hasn’t changed your withholding to reflect your remote work location, it may still have you down as working in the office. That could mean that you’re not having taxes withheld for the state in which you’re now working, which could be a liability come tax time, and you might have to file a nonresident tax return taxes to recover money withheld to the state where your office is located.
So, if your paycheck still notes tax withholding for the state the office is in, rather than the state you’re working in, you might want to talk to your company about changing this.
Another complication? There’s the physical presence test. If you live in more than one state for more than a certain number of days – and the number of days varies by state – those states could decide that you lived there long enough – in other words, become a “statutory resident” — to have to pay taxes there, too.
“Some states, such as Colorado and Alabama, require only a single day of in-state work to levy state income tax,” writes Schanel & Associates CPAs. “Other states have a more generous threshold of 60 days of work before employees need to pay state income tax. Other states have an income threshold. For example, Georgia requires that non-residents who earn a portion of their income in Georgia file a Georgia tax return if their compensation in Georgia is greater than five percent of all of their income, or $5,000, whichever is larger.”
Think this is complicated? It can be worse.
What is the Convenience Rule?
In many states, where you live in one and work in another, one state will give you a break and give you a credit for the taxes you paid to the other state, or not tax you at all, through what’s called a “reciprocal agreement.” But in a few states, if your employer is in that state, you have to pay taxes to that state even if you neither live nor work there yourself. Those states are Arkansas, Connecticut, Delaware, Massachusetts, Nebraska, New York, and Pennsylvania.
That’s because those states have enacted something called a “convenience of the employer” rule, or a “convenience rule” for short. If your employer is in one of those states, and you work in a different state, you must pay taxes to the employer’s states unless you’re working in the different state for the convenience of the employer – for example, running a sales or repair office in that other state.
As remote work in other states becomes more common, some people are concerned that more states may enact convenience rules because they are concerned about the amount of income tax revenue they’re losing. Massachusetts, in fact, instituted such a rule after the COVID-19 pandemic started because of how many of its residents were moving to nearby New Hampshire, which doesn’t have any income tax at all.
“Massachusetts is clearly within its rights to tax income earned in the state,” writes the Tax Foundation. “But when that person’s office becomes their Nashua home, what is Massachusetts’ ongoing claim? Just that their employer owns a vacant office building in Boston?” Moreover, if the work is no longer being performed in another state, reciprocity agreements may no longer apply, meaning that employees could be taxed by two states, the organization adds.
A number of other states, including New Jersey, Connecticut, Hawaii, and Iowa, filed amicus briefs in that case, because they saw this as a relevant issue for them, too. For example, New Jersey residents who used to work in New York City but who are now working at home still must pay taxes to New York.
Remote employees are getting tax-disadvantaged another way. It used to be that an employee who set up a spare room as a home office to work in could take tax deductions for setting up and working in that office, writes U.S. News and World Report. But the Tax Cut and Jobs Act of 2017 took away those deductions for employees, the magazine explained.
Remote contract and other self-employed workers can still take the home office deduction, U.S. News added.
W2 vs. 1099 Workers
In addition to being able to take the home office deduction, there are several other differences between W2 – employed – and 1099 – contract workers. And again, those differences can vary based on the states
For 1099 workers, “This means you are responsible for figuring out which states you owe taxes to, based on where you reside and where you were when you earned the money,” writes CNBC. However, the calculation is not based specifically on the time spent in different states, but rather a combination of the amount earned in those states as well as factors such as whether you have employees working for you and your sales revenue, the website adds.
Ultimately, it’s important to research the tax rules for both the state you live in and the state your company is located — and be aware that these rules may be changing.
If you work with a tax professional, make sure they’re aware of the ramifications as well, especially if you don’t work in a neighboring state. While many tax professionals are accustomed to someone living in New Jersey and working in New York, for example, they may be less familiar with the situation of someone living in Arkansas and working in California.
Consult a tax professional if you lived in more than one state, or if your company is based in a convenience rule state.