The most pressing challenge for many business owners is staying fully staffed. Having the ability to hire people from around the country (and around the world) is an incredible edge some owners have over brick-and-mortar businesses that need employees to physically be at their locations.
Thousands of companies were forced to accelerate the shift to adopt mobile work practices during the pandemic. Even if it was on their radar previously, managing their taxes and making sure they are doing all the right things—in all the right states—is likely much more complex than they anticipated.
Business owners know that they are obligated to collect and remit various taxes in the states where they reside, but things get more complicated when they have employees that work in other states. Each state creates their own rules for those that work remotely, and they affect both employers and employees. Some rules are triggered by working in their state a certain amount of time or by earning a certain amount of money during the year.
What happens if an employee works in the employer’s state, but lives in a neighboring state? In which jurisdiction should the employer withhold taxes–the state where the work is performed or the state where the employee lives? A common relief regarding withholding requirements related to employer-employee relationship involving neighboring states is the concept of reciprocal agreements. These agreements allow the employer to only withhold taxes in the state of residence as opposed to the state where the employee works. Employers should ensure that such agreements are in place before they implement such practice.
State taxes on wages vary wildly and it’s important for employees to understand that when they work remotely from another state, they are often required to file tax returns in both the state they reside in and the state(s) where they physically work–subject to certain exception due to reciprocal agreements as discussed above. This can be confusing and result in employees not meeting their compliance obligations.
Tip: While employers are not obligated to educate their employees about their tax obligations—including whether they may be required (or benefit from) filing multi-state tax returns—it is necessary to clearly disclose taxes are being captured and to which state they are being remitted.
Some states don’t have withholding requirements unless the employer themselves does business there or if there is sufficient economic presence; however, the trend has been moving toward making any payment of wages to a resident trigger employer registration and a tax withholding requirement.
Allowing employees to work from other states may trigger an economic nexus. Nexus is a term used to describe when a business has made a significant enough connection with a state to allow that state to impose a tax. Each type of tax (income tax, franchise tax, gross receipts tax, payroll tax, sales tax, etc.) has its own nexus standard under the laws of the state. When the nexus standard is met, a taxable presence is established. Prior to 2018, there was generally a physical presence needed for a business to establish nexus for sales tax purposes. However, the U.S. Supreme Court overturned prior law in their ruling in, South Dakota v. Wayfair (2018), it’s often just referred to as Wayfair. This case allowed the State of South Dakota to impose a sales tax based on a business having “economic” nexus. Economic nexus is a standard based on a bright line test consisting of a threshold sales amount or number of transactions with customers in the state, removing any physical presence requirement. Within a very short time after the Wayfair decision, most states adopted similar rules using sales thresholds to establish sales tax nexus. Remote sellers must now monitor sales and transaction volumes in the various states to determine if economic nexus has been created.
Tip: For each type of tax, business owners should consult with their tax advisors if registration or business licensing in each state is required, and track and meet all obligations and due dates such as those for returns, as applicable.
Employers need to take a close look at sales tax requirements at the city and county level. While most states have adopted methods to streamline their collection to reduce the onus on business owners, others have not yet made that transition and separate tax returns may still be required at the city or county level.
Similar to sales taxes, allowing employees to work from other states may trigger an income tax nexus for the business in jurisdictions where the company has not had any income tax presence in the past. Decision makers should consult with their tax advisor to determine if any action is necessary such as income tax registrations or tax return filing for the company to be fully compliant with the appropriate state/city income tax laws.
Remote Work Challenges
The reality is that the ‘temporary’ shift to remote work is no longer temporary for many of us. Attracting and retaining staff can require that we move out of our comfort zone and allow people to work remotely while managing the related tax obligations.
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If your company needs assistance in reviewing or managing the tax challenges posed by having a remote workforce, we can help. Contact us today to learn more.