The owner of a New York business that employs nonresidents who, as a result of the pandemic, are working remotely from their homes in another state,[iii] should be attuned to recent developments that may affect their obligation to withhold New York taxes from the compensation payable to their nonresident, telecommuting employees.
The Tax Heard Round the States[iv]
On April 21, 2020, the Massachusetts Department of Revenue published a Technical Information Release[v] in which the Department sought to explain the income tax sourcing and withholding rules applicable to those non-resident employees who began telecommuting following (1) the State’s declaration of a state of emergency in response to the COVID-19 pandemic,[vi] and (2) the State’s emergency order requiring all nonessential businesses to close their physical workplaces and facilities.[vii]
According to the release, all compensation received for services performed by a nonresident who, immediately prior to the state of emergency, was an employee engaged in performing such services in Massachusetts, and who began performing services from a location outside Massachusetts due to a “pandemic-related circumstance,” will continue to be treated as Massachusetts source income subject to the Commonwealth’s personal income tax, and to income tax withholding by their Massachusetts employer.
New Hampshire – which does not have a personal income tax[viii] – was not pleased. What ensued was a months-long war of words between the two neighbors, which last week culminated in a Constitutional challenge when New Hampshire brought an action against Massachusetts in the U.S. Supreme Court[ix] claiming, among other things, that Massachusetts was infringing upon New Hampshire’s sovereignty by seeking to impose a tax upon New Hampshire residents in respect of income they earned in New Hampshire – not in Massachusetts.[x]
General Rule – Except in New York[xi]
It has long been accepted that a State may tax a nonresident individual only with respect to income that is generated by, or earned from, sources within that State.[xii] For example, a State may tax a nonresident on their rental income from real property located in the State, or on their share of partnership income from a business operating in the State.[xiii]
The same source-based limitation applies to the case of a nonresident individual who is employed by a business that operates within the State; specifically, the State may tax the nonresident employee’s wages, paid by their resident employer, only to the extent such wages are attributable to services rendered – i.e., earned – by the nonresident employee within the State, which is usually determined by comparing the number of days worked by the nonresident within the State with their number of days worked without the State.[xiv]
In other words, those wages earned by a nonresident employee for work performed outside the State may not be taxed by the State, and the employer is not required to withhold such taxes on behalf of the State.
In the case of a nonresident employee who performs services for their employer both within and without the State, New York law is similar to that of other states; it provides that the nonresident’s income derived from New York sources includes that proportion of their total compensation for services rendered as an employee which the total number of working days employed within New York bears to the total number of working days employed both within and without New York.
However, any allowance claimed for days worked outside New York must be based upon “the performance of services which of necessity, as distinguished from the convenience, obligate the employee to out-of-state duties” in the service of their employer.[xv]
Is the Hudson Wide Enough?[xvi]
Coincidentally with the filing of New Hampshire’s complaint against Massachusetts, New York’s Department of Taxation and Finance issued guidance regarding the income taxation of certain nonresidents. Specifically, according to a set of newly-issued FAQs,[xvii] if a nonresident’s assigned or primary office is in New York, their days telecommuting during the pandemic will be considered days worked in New York unless the nonresident’s New York employer has established a bona fide employer office at the nonresident’s “telecommuting location.”[xviii]
In general, unless the New York employer of a nonresident employee[xix] specifically acts to establish a bona fide employer office at the employee’s telecommuting location, the nonresident employee will continue to owe New York personal income tax on income earned while telecommuting.
Convenience of the Employer
The foregoing represents what may be described as an extension of New York’s “convenience of the employer” rule, under which a nonresident employee whose assigned or primary office is in New York State, but who spends a “normal work day” at their home office outside New York, will nevertheless be treated as having worked in New York on that day, unless the nonresident employee can demonstrate that their home office is a bona fide employer office.[xx]
A number of factors are considered in determining whether a nonresident’s New York employer has established a “bona fide employer office” at the employee’s telecommuting location outside New York; specifically, the state in which the employee resides.
These factors are divided into three categories: the primary factor, secondary factors, and other factors. In order for an office to be considered a bona fide employer office, the office must meet either: (a) the primary factor (not likely[xxi]), or (b)(i) at least 4 of the secondary factors[xxii] and (ii) 3 of the other factors.[xxiii]
In general, unless the employer specifically acted to establish a bona fide employer office at the nonresident employee’s telecommuting location, the nonresident employee will continue to owe New York income tax on income earned while telecommuting.
Should the Rule Apply?
The question, of course, is whether it is appropriate for New York to apply its “convenience” rule given the circumstances under which so many nonresident employees are telecommuting.
There was nothing voluntary about their decision to work from home. Indeed, on March 7, 2020, New York’s Governor Cuomo declared a state of emergency, which was followed on March 20 by a statewide order that all non-essential workers work from home.[xxiv]
According to many jaded observers, what we are witnessing does not reflect a “logical” extension of New York’s rule but, rather, an attempt by the State to make up for lost tax revenues caused by the stay-at-home order and the resulting economic shutdown.
Although New York may defend its taxation of nonresident employees, in part, by reminding them that they may be entitled to a credit against the tax owing to their state of domicile for the tax paid to New York – thereby avoiding double taxation of such wages – the fact remains that such a credit has the effect of removing tax dollars from the employee’s fiscally-challenged state of domicile, and moving them to New York.
We’re Not Gonna Take It [xxv]
Within days of the issuance of New York’s guidance and the filing of New Hampshire’s complaint against Massachusetts, the New Jersey Senate responded with a bill[xxvi] which begins as follows:
The Legislature finds and declares that:
a. Thousands of New Jersey residents, many of whom work from home, have New York income taxes taken from their paychecks because their employers are located in the State of New York.
b. New Jersey allows those residents to claim a tax credit against their New Jersey income tax liability for the taxes they paid to New York, so that their income is not taxed again.
c. It is grossly inequitable that the State of New York receives and retains income tax revenue from New Jersey residents who may only infrequently and sporadically travel to New York to conduct business.
d. The inequity extends to New Jersey residents who may be required to pay higher New York income tax rates.
e. Current inequities have been growing over time as technology improvements have allowed New York businesses to decrease office space available to New Jersey residents working in New York and effectively use New Jersey’s infrastructure and services as support for their employees.
f. Current inequities have further been exacerbated by COVID-19, which is hastening the trend of New Jersey residents no longer truly working in New York and New York businesses downsizing New York office space available to New Jersey residents.
Unlike feisty New Hampshire, the New Jersey bill, as originally introduced, merely directs the State Treasurer to prepare and submit a report[xxvii] concerning New York’s taxation of the income earned by New Jersey residents, to determine how much credit New Jersey gives for taxes paid to New York,[xxviii] and to make recommendations for how New Jersey may resolve the “inequitable tax treatment” of New Jersey residents who commute to work for employers in New York.
The bill was almost immediately amended[xxix] to also request that the State consider participating in the above-referenced litigation between New Hampshire and Massachusetts.
The issue of telecommuting preceded the COVID-19 pandemic and the resulting shutdown of many segments of the economy.
The “stay-at-home” orders – like those issued by Massachusetts and by New York – and the effect of the pandemic on the coffers of these and many other states, have brought into sharper focus the question of when it is appropriate for a state to tax the wages earned by nonresident telecommuters, and to require the in-state (or resident) employers of such individuals to collect this tax.
These circumstances have also raised the possibility that the states in which the telecommuting employees are domiciled may try to tax the nonresident businesses that employ them, thereby recapturing the tax revenue lost to credits.
This option will certainly be attractive in the case of New Hampshire and New Jersey,[xxx] who are fiscally tied, in a sense, to their more economically robust neighbors.
Moreover, this approach may be legally supportable under the Supreme Court’s reasoning in South Dakota v. Wayfair, and its adoption of the economic nexus standard.[xxxi] In fact, a recent survey of state tax departments revealed that many states consider the presence of a telecommuting employee of an out-of-state business as sufficient economic nexus for purposes of taxing such business.[xxxii]
In light of the foregoing, what is a New York business to do if some of its nonresident employees are telecommuting? First, investigate the tax treatment afforded by the states in which the telecommuting employees reside; and, second, keep an eye on New Hampshire v. Massachusetts.
[i] Have you read Drums Along the Mohawk, by Walter Edmonds? The story is set on the frontier of Upstate New York during the American Revolution. As you know, that “trouble” began in Massachusetts, then spread southward.
[ii] Do you discern a pattern?
[iii] In the case of New York City and the “adjoining” counties, we’re probably looking at New Jersey and Connecticut. Heading north, though, brings Massachusetts and Vermont into play; westward, we’re considering Pennsylvania.
[iv] Get it? “Shot heard round the world?” Lexington and Concord, April 1775?
[v] TIR 20-5: Massachusetts Tax Implications of an Employee Working Remotely due to the COVID-19 Pandemic.
See also TIR 20-10, which revised and extended TIR 20-10. https://www.mass.gov/technical-information-release/tir-20-10-revised-guidance-on-the-massachusetts-tax-implications-of#v-pass-through-entities The TIR was issued following the promulgation of emergency regulation 830 CMR 62.5A.3: Massachusetts Source Income of Non-Residents Telecommuting due to the COVID-19 Pandemic.
[viii] Well, not quite. The State does impose a tax on certain investment income above a threshold amount.
[ix] Article III, Section 2 of the Constitution gives the Court original jurisdiction “to controversies between two or more states.”
[x] The complaint in New Hampshire v. Massachusetts, was filed on October 19, 2020. https://www.governor.nh.gov/sites/g/files/ehbemt336/files/documents/nh-v-ma-action.pdf
[xi] And very few others.
[xii] The same rules generally apply between nations.
[xiii] Generally speaking, the nonresident partner is deemed to be engaged in the business conducted by the partnership.
[xiv] Physical presence is key.
[xv] 20 NYCRR 132.18.
[xvi] I promise not to say anything derogatory about New Jersey in this week’s post.
Trivia: Did you know that, during much of the 18th Century, the two colonies were engaged in armed conflict with one another over the location of their common border? YCMUTS. (Or is it YCMTSU?)
[xvii] Update October 19, 2020. Frequently Asked Questions about Filing Requirements, Residency, and Telecommuting for New York State Personal Income Tax. https://www.tax.ny.gov/pit/file/nonresident-faqs.htm#telecommuting
[xviii] Who speaks like that? By the way, Merriam-Webster defines “telecommuting” as working “at home by the use of an electronic linkup with a central office.”
[xix] We assume for purposes of this post that the employee is, in fact, a nonresident of New York.
All too frequently, however, an employee who is domiciled elsewhere, but who works in New York, will stumble into New York resident status for tax purposes by leasing or purchasing an apartment in New York City, or by acquiring a second home in New York (which need not be within easy reach of the employee’s place of business, but which must be suitable for year-round use). If the State finds that the individual has “maintained” a “permanent place of abode” in the State for “substantially all” of the tax year, has a “residential interest” in such place of abode (which is proving to be an evidentiary challenge), and has been present in New York for more than 183 days during such year, the individual will be taxed as a so-called “statutory resident” of the State for that year. https://www.taxlawforchb.com/2019/09/statutory-residence-in-ny-the-permanent-place-of-abode-test-is-in-need-of-repair/
[xx] TSB-M-06(5)I (May 15, 2006). Any day spent at the home office that is not a normal work day would be considered a nonworking day. A normal work day means any day that the taxpayer performed the usual duties of his or her job. For this purpose, responding to occasional phone calls or emails, reading professional journals or being available if needed does not constitute performing the usual duties of his or her job.
[xxi] The employee’s duties require the use of special facilities that cannot be made available at the employer’s place of business, but those facilities are available at or near the employee’s home.
[xxii] The home office is a requirement or condition of employment; The employer has a bona fide business purpose for the employee’s home office location; The employee performs some of the core duties of his or her employment at the home office; The employee meets or deals with clients, patients or customers on a regular and continuous basis at the home office; The employer does not provide the employee with designated office space or other regular work accommodations at one of its regular places of business; Employer reimbursement of expenses for the home office.
[xxiii] The employer maintains a separate telephone line and listing for the home office; The employee’s home office address and phone number is listed on the business letterhead and/or business cards of the employer; The employee uses a specific area of the home exclusively to conduct the business of the employer that is separate from the living area. The home office will not meet this factor if the area is used for both business and personal purposes; The employer’s business is selling products at wholesale or retail and the employee keeps an inventory of the products or product samples in the home office for use in the employer’s business; Business records of the employer are stored at the employee’s home office; The home office location has a sign indicating a place of business of the employer; Advertising for the employer shows the employee’s home office as one of the employer’s places of business; The home office is covered by a business insurance policy or by a business rider to the employee’s homeowner insurance policy; The employee is entitled to and actually claims a deduction for home office expenses for federal income tax purposes; The employee is not an officer of the company.
[xxv] Twisted Sister and New Jersey?
[xxvi] S-3064. https://www.njleg.state.nj.us/2020/Bills/S3500/3064_I1.PDF. The bill quickly advanced through the Senate’s Budget and Appropriations Committee.
[xxvii] Within six months of the date of enactment, which remains to be seen.
[xxviii] New York State’s top personal income tax rate is 8.82%. New York City does not tax nonresidents. Until recently, New Jersey’s top rate on individuals – 10.75% – kicked in at gross income exceeding $5 million; that threshold has now been reduced to $1 million. https://taxfoundation.org/new-jersey-millionaires-tax-fy-2021/
[xxx] I hope folks don’t take this the wrong way. I’m not denigrating these states. For example, both New Jersey and Connecticut recently announced that their budget gaps were not as bad as expected. Most observers have attributed this to the strength of Wall Street firms . . . located in New York. See Bloomberg’s Daily Tax Report, “Connecticut Deficit Shrinks as Covid Tax Hit Less Than Forecast” (October 21, 2020).
[xxxi] 138 S. Ct. 2080 (2018). Even without Wayfair, the physical presence of a resident-telecommuting employee performing a significant function for the out-of-state business-employer may suffice.
[xxxii] The report can be obtained here: https://pro.bloombergtax.com/reports/survey-of-state-tax-departments/?trackingcode=BTXS205632 .
It should be noted that some states have chosen not to treat a resident employee, who is telecommuting for an out-of-state employer because of COVID-19 restrictions, as a point of nexus on which to justify the taxation of such employer.