Remote work has revolutionized a number of industries. It has made job environments more competitive, and allows companies to hire top talent with ease. However, a remote workforce can pose significant tax challenges. The primary consideration for remote worker tax is your tax nexus.
By employing workers from different states, your company may be subject to many state and local tax laws that didn’t apply to you in the past. What’s more, even if you source your staff through a professional employer organization (PEO), your business is still liable for a state income tax nexus.
Why Remote Worker Tax Is So Complicated
Your business must follow the various tax laws of your state with regard to payroll, income tax and sales tax. However, by employing workers from a different state, you also need to register with the local and state tax agencies for every state in which your employees live. This includes labor and unemployment agencies.
As such, the risks of double taxation or unintentionally withholding state taxes are significant, especially when you consider that some states have inconsistent tax laws, or no form of coordination for remote worker tax.
This is where state tax reciprocity comes in. These are agreements between two or more states to not tax the income of employees who commute (or telecommute) into one state from another. After the COVID pandemic and the subsequent rise of remote workers, several states entered into these kinds of agreements.
And then there are the ‘convenience rules’ imposed by states like Connecticut, Delaware, Massachusetts, Nebraska, New York, and Pennsylvania. These states allow employers to withhold state taxes for their remote workers if the person works for convenience rather than due to employer necessity.
For example, consider an employee from a different location telecommuting to their office in New York. Per state regulations, they are considered to have worked in New York, unless the employer has a location set up in the worker’s state.
What Is a Tax Nexus?
A tax nexus is a connection that allows a specific jurisdiction to legally impose taxes on an entity. In terms of remote worker tax, this means that employing staff in different states can cause your company to generate a nexus for business taxes like income tax and sales tax. This also affects state registration or licensing.
That generally subjects your company to various state and local registration and filing requirements, resulting in a tax liability. It can also mean an increased cost for compliance.
How Does a Nexus Affect Remote Work Tax?
A tax nexus can severely impact corporate compliance. That’s why it’s important to know exactly where your remote workers live, especially if they move to a new location. After all, each employee needs to be registered in their tax jurisdiction for tax filing and withholding. As the employer, this is your responsibility.
Also keep in mind that if you have employees who work part-time in different states, their earnings may need to be divided between the states for income tax purposes.
A tax nexus due to remote employees affects the following:
Payroll tax
Usually, your staff’s home state has jurisdiction over the entirety of an individual’s income, no matter where or how it was earned. When your employee’s work state differs from their home state, they’ll usually receive a credit in their home state for taxes paid to their work state.
States with reciprocal agreements allow resident state tax rules and withholding, instead of the work state rules. Without reciprocal agreements, once an employee reaches their state’s threshold number of workdays, the withholding requirements are activated.
A nexus also affects other types of compensation. This includes commissions, stock options, and bonuses, as state rules for these payments may differ.
Income tax
Where your staff is located also affects where you’ll be subject to income tax reporting and payment. Currently, there are two federal constitutional provisions in place that dictate how out-of-state income taxes can be applied; the due process and commerce clauses.
The first clause means that your company needs minimum contact with another state, or a nexus, to be charged income tax. The second depends on a Complete Auto Transit test. In short, it determines whether your taxes are apportioned fairly and don’t discriminate against interstate commerce.
States use a number of different formulas to determine how corporate profits are taxed, such as single sales factor (SSF). Alternatively, there’s three- or four-factor apportionment, which includes sales, as well as a percentage of property and payroll within the state. This is overseen by an intergovernmental state tax agency called the Multistate Tax Compact (MTC). This body aims to promote uniform and consistent tax policies and administration among states. In 2002, the MTC developed the factor presence nexus to calculate the percentage that states use for apportionment of income.
Non-income-based tax
Having remote employees might also subject your business to non-income-based taxes. This could result in a cash tax expense even if your company has taxable net operating losses.
For example, some states implement gross receipts taxes for businesses employing remote workers. Others impose minimum tax requirements on businesses with a state nexus, with penalties for noncompliance.
How to mitigate income nexus risks
It’s not possible to completely avoid the challenges posed by remote worker tax and an income tax nexus. Although there are ways to make the process run more efficiently, including:
- Transferring your workers: If your company operates a local branch or office in the same state as a remote employee, consider transferring the worker to that office.
- Creating secondments: These are employee lease agreements, in which one company or branch leases an employee to another.
- Making your employees independent contractors: This can be a solution for employees who only need to work remotely temporarily. After all, you don’t have to withhold income taxes for independent contractors. However, this can still pose some issues.
What If You Employ Remote Workers Through A PEO?
Many companies use Professional Employer Organizations (PEOs) to handle their HR management and hiring processes. This saves on the resources needed for an in-house HR department.
PEOs usually employ a worker and enter into a service contract with your business, with the employee regarded as an independent contractor. Using PEOs that are located in the same jurisdiction as your remote employee can make tax filings easier. However, it does not protect your company from a state income tax nexus.
The employee still performs services on behalf of your company. Their time is also devoted to business activities as if you employed them directly. Also, if you employ independent contractors from a different state, you might have to file different state and federal 1099 forms.
Even if you use the services of a PEO for hiring remote workers, you must still assess employee location to determine your nexus and the required tax filings.
How A Professional Can Help You
Despite the myriad challenges associated with remote worker tax, proper planning can alleviate the burden. By understanding each state’s tax requirements, you can ensure that your business remains compliant, no matter where your employees live.
It’s best to consult with legal and tax advisors for updates about the various compliance requirements of operating a business across states. These professionals can also advise you on a remote workforce from other states.
For assistance with your remote worker tax needs, schedule a Discovery Call with one of our CPAs.
The information presented in this blog article is provided for informational purposes only. The information does not constitute legal, accounting, tax advice, or other professional services. We make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability, or availability of the information contained herein. Use the information at your own risk. We disclaim all liability for any actions taken or not taken based on the contents of this blog. The use or interpretation of this information is solely at your discretion. For full guidance, consult with qualified professionals in the relevant fields.
