Mending Walls

“Good fences make good neighbors,” or so Robert Frost’s neighbor from “beyond the hill” says to him when “on a day” they “meet to walk the line and set the wall between” them “once again.” The neighbor repeats this proverb in response both to Frost’s question regarding the purpose of the wall – “There where it is we do not need the wall,” Frost tells us– and to his observation that “something there is that doesn’t love a wall, that wants it down.”[i]

How might New Jersey or Connecticut apply this proverb when addressing New York’s recent efforts to extend the reach of its taxing jurisdiction to nonresident employees who are telecommuting from their homes in these neighboring States?

Taxing Nonresidents

It has long been accepted that a State may tax a nonresident individual only with respect to income from sources within that State. 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.

The same source-based limitation applies to the case of an individual who provides services within a State of which they are not a resident; specifically, the State may tax the nonresident’s compensation only to the extent such compensation is attributable to services rendered by the nonresident 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.

In other words, those wages earned by a nonresident employee for work performed outside a State may not be taxed by that State.

New York

In the case of a nonresident employee who performs services for their employer both within and without the State, New York’s 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.[ii]

Under these rules, New York has been able to collect billions of dollars of income tax, annually, from several hundred thousand New Jersey and Connecticut residents who commuted to jobs in New York every day – before the pandemic, that is.

In March of this year, New York’s Governor Cuomo issued a statewide order that all non-essential workers work from home; this included many nonresidents who commuted to jobs in New York. Following this order, those nonresidents who could do so telecommuted “to” their New York jobs.

Convenience of the Employer

Then, just a few months ago, in what may be described as an aggressive extension of New York’s “convenience of the employer” rule, New York issued guidance according to which the days a nonresident telecommuted from their home outside New York during the pandemic – a “normal work day” – would be considered days worked in New York if the nonresident’s “assigned or primary office” was in New York, unless the nonresident’s New York employer specifically acted to establish a bona fide employer office at the nonresident employee’s non-New York “telecommuting location.”

In the absence of such a bona fide employer office at the employee’s telecommuting location – say, in New Jersey or Connecticut – the nonresident employee would continue to owe New York personal income tax on income earned while telecommuting from their home in one of those States.

A number of factors[iii] 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. It is no easy thing to demonstrate that these factors have been satisfied.

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 forced to telecommute.

In the first instance, there was nothing voluntary about their decision to work from home. They were ordered to do so by the Governor of New York. Then there is their very reasonable concern for their safety and the well-being of those close to them.

According to many jaded observers – myself included – 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 issued in response to the pandemic and the resulting economic shutdown.

“Like a Good Neighbor”[iv]

A Connecticut resident is subject to Connecticut income tax, and a New Jersey resident is subject to New Jersey income tax, on all of their income regardless of where the income is earned or sourced. However, if the Connecticut resident or the New Jersey resident works in another State that imposes an income tax on compensation earned within that State – New York comes to mind – the individual is also subject to tax in the State in which they work.

That is not to say that a resident of, say, New Jersey with compensation income for services performed in New York will necessarily pay tax on such income to both New Jersey and New York.

The New Jersey resident will have to report this income on a New York nonresident income tax return, and it will remit to Albany the New York income tax imposed on such New York source income.

At the same time, the New Jersey resident will also have to report this compensation income on their New Jersey resident return. However, in determining their New Jersey resident tax liability on such income, the resident may be eligible for a credit for any income taxes paid to New York on the income.[v]

In other words, New Jersey will forego collecting tax from a resident taxpayer on income sourced in New York to the extent the income was taxed by New York. Thus, the credit has the effect of shifting tax revenue away from the New Jersey taxpayer’s State of residence and into the State (New York) in which the income was earned.[vi]

New Jersey’s Reaction

Within days of the issuance of New York’s above-described guidance, the New Jersey Senate responded with a bill[vii] which began 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.”

The bill directs the State Treasurer to prepare and submit a report 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, 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 also requests that the State consider participating in the potential litigation between New Hampshire and Massachusetts, described below.

New Hampshire vs. Massachusetts

New York is not the only State that appears to be flexing its economic muscle in the face of its smaller, economically less robust neighbors, many residents of which commute to jobs located in the larger State. In April of this year, Massachusetts sought to explain its income tax sourcing rules applicable to those nonresident employees who began telecommuting following the Commonwealth’s emergency order requiring all nonessential businesses in Massachusetts to close their physical workplaces and facilities.

According to Massachusetts, all compensation received for services performed by a nonresident who, immediately prior to the emergency order, was an employee engaged in performing services in Massachusetts, and who began performing services from a location outside Massachusetts due to a “pandemic-related circumstance,” would continue to be treated as Massachusetts source income subject to the Commonwealth’s personal income tax.

New Hampshire reacted by filing a complaint against Massachusetts in the U.S. Supreme Court 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.[viii]

Amicus Briefs

Last week, New Jersey[ix] and Connecticut filed a “friends of the court” brief[x] in which they (i) described their own experience with New York’s efforts to tax their residents, (ii) supported New Hampshire’s request that the Supreme Court accept the action initiated by the Granite State, and (iii) urged the Court the rule in favor of New Hampshire – and, by extension, New Jersey and Connecticut – on the merits.

According to the amicus brief, New York[xi] levies taxes on nonresident employees for income they earn while working at home in their New Jersey or Connecticut residences, as the case may be. The imposition of these taxes, the brief claims, is inconsistent with the Federal Constitution because they are not fairly apportioned. According to the brief, the “central purpose” of the fair apportionment requirement is “to ensure that each State taxes only its fair share” of a tax base. A State does not tax its “fair share,” the brief asserts, when the State directly taxes the income that nonresidents generated outside the State’s borders by working from home.

In urging the Court to exercise its original jurisdiction to accept New Hampshire’s petition, the amicus brief illustrated the impact of the Massachusetts and New York tax schemes as follows: “As New Hampshire highlights, an individual who spends her day working at home in New Hampshire could be required to pay Massachusetts taxes on her entire income, even though her Home State [New Hampshire] (where she spent the entire month) levies no such tax. . . . Similar rules apply . . . to the Connecticut and New Jersey residents who work most days from their Stamford or Jersey City apartments for a company based in Manhattan.”

In addition, the taxes paid by these nonresident taxpayers to New York have an adverse effect upon New Jersey’s and Connecticut’s finances because these States – in order to mitigate the risk of double taxation on their residents who have New York source compensation income – voluntarily provide a credit to their residents for taxes these residents have paid to New York. In doing so, New Jersey and Connecticut are sacrificing billions of dollars in tax revenue, while New York enjoys a windfall.

This is particularly troubling, the brief avers, because New Jersey and Connecticut provide police, medical and other services to their residents working at home without collecting tax revenue. “Yet that is the Hobson’s Choice to which [New Jersey and Connecticut] are put: doubly tax residents’ income or suffer fiscal consequences.”

The Pandemic

To drive its point home, the amicus brief then addresses the “unprecedented growth in work from home borne of the ongoing COVID-19 pandemic,” explaining that approximately “70 percent of U.S. employees ‘always’ or ‘sometimes’ worked from their home.”

Before the emergence of COVID-19, the brief explains, “more than 400,000 residents of amici New Jersey commuted to jobs in New York City (as did up to 78,000 residents of amici Connecticut).” However,

“This interstate travel came to an abrupt halt in March 2020, when rising COVID-19 cases compelled the New York Governor to prohibit employees of non-essential businesses from reporting to the workplace. Offices and stores in New York City were permitted to reopen in June 2020, but because of the ongoing pandemic, employers are still subject to various capacity limits, employers must take measures to reduce interpersonal contact in the office, and many former commuters keep working from home.”

Notwithstanding that these individuals were compelled, in effect, to work remotely from home, the briefs continues,

“New York made clear that nonresidents who are working from home due to the COVID-19 pandemic should consider their days working from home on account of these orders as ‘days worked in [New York] unless [their] employer has established a bona fide employer office at [their] telecommuting location.’ Given the stringent test for a bona fide employer office, residents working from home in amici New Jersey or Connecticut are virtually certain to fail New York’s test and will be required to pay income taxes to New York even if they never left the borders of their Home State.”

Given the number of individual taxpayers working from home, the brief concludes, “[t]he financial impact” of New York’s tax scheme cannot be understated. The tax credits that “home” States, like New Jersey and Connecticut, grant their residents who telecommute “to New York” will cost these States billions of dollars.[xii]

What’s Next?

The competition among the States for tax dollars is certain to get worse. The continuing pandemic, what promises to be a prolonged economic downturn, and Congress’s failure to include any meaningful financial relief for the States in the stimulus legislation enacted yesterday, do not bode well for the States which provide credits to those of their residents who will be telecommuting to work for an employer in a neighboring State to which they pay income taxes in respect of their compensation.

This situation may get worse in the short run if the Democrats fail to carry Georgia’s two Senate seats, thereby leaving Mr. McConnell in a position to squelch any future proposals that would provide significant financial aid to State and local governments.

Looking further down the road, unless States like New York, New Jersey and Connecticut come to some mutually beneficial agreement regarding the taxation of nonresidents who telecommute, or unless the Supreme Court accepts New Hampshire’s case and settles the matter, or unless Congress elects to provide a nationwide rule – don’t hold your breath – employers and their nonresident employees will continue to be pieces in the games that States are being forced to play.

Of course, that assumes no change in the status quo. The telecommuting experience of many employers and employees during the pandemic, however, is certain to change the way these folks do business, and especially the location from which such business is conducted[xiii] and how it is taxed. These circumstances will raise 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 Jersey. Moreover, this approach may be legally supportable under the Supreme Court’s reasoning in South Dakota v. Wayfair, and its adoption of an economic nexus standard.[xiv]

Worse still, from the perspective of these States, and perhaps more likely following the proposal of income tax increases by many of these States,[xv] these employers (and, in many cases, their employees as well) will move to a warmer, tax-friendlier jurisdiction, thereby depriving both the “work State” and the “home state” of revenues.

Walls. “‘Why do they make good neighbors?”


[i] . Robert Frost worked a farm in New Hampshire for nine years, during which period he wrote many of his poems.

[ii] 20 NYCRR 132.18.

[iii] 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, or (b)(i) at least 4 of the secondary factors and (ii) 3 of the other factors.

[iv] Some jingles just won’t go away.

[v] The credit reduces the resident’s New Jersey Income Tax liability so that they don’t pay taxes twice on the same income – once to New York as a nonresident, and once to New Jersey as a resident.

It should be noted that, in order for the New Jersey resident to enjoy a credit for taxes paid to New York, such taxes must have been paid with respect to New York source income.

What about a New Jersey domiciliary who is determined to be a New York statutory resident for a particular year? In that case, the New Jersey domiciliary would be subject to tax as a resident of both states. What if the income on which this tax is imposed is attributable to an intangible, like the gain from the sale of shares of stock?

New Jersey is unlikely to treat such gain as arising from a New York source; thus, no credit would be allowed for the New York tax paid for purposes of determining the New Jersey resident’s New Jersey income tax.

See the following example of this principle applied to a Connecticut domiciliary who was found to be a statutory resident of New York: .

[vi] This should be compared to the situation of a New Jersey resident who works in Pennsylvania, say, in Philadelphia. Under a reciprocity agreement between the two states, the New Jersey taxpayer will pay income tax only to the jurisdiction in which they reside – New Jersey – and not in the jurisdiction where they work Pennsylvania).

[vii] S-3064. The bill is now pending in the Assembly.

[viii] The complaint in New Hampshire v. Massachusetts was filed on October 19, 2020.

New Hampshire does not impose an income tax.

[ix] In accordance with the directive in S-3064, above.

[x] Amicus curiae.

[xi] And Massachusetts.

[xii] In 2018, New Jersey credited more than $2 billion to resident taxpayers who worked for out-of-state employers; virtually all of this income tax credit related to work done for New York employers.

[xiii] Many business owners are wondering about certain expenses, especially exorbitant rents for the use of office space in the face of an increasing number of telecommuting employees.

[xiv] 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.

In fact, a fairly 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.

It should be noted, however, 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.

[xv] We’re waiting for the veto-proof New York legislature to act.