Taxes and working remotely
Employees working remotely could face issues with their taxes, including double state tax on wages depending on their state of residence and location of their employer.
According to a 2018 annual report from the Bureau of Labor Statistics, 23.7% of employed persons who worked on an average day worked from their home or from a location other than their workplace for some amount of time. While working remotely has its perks--including eliminating commuting time--these unique arrangements can also have downsides. One negative aspect is that remote workers can face state tax issues when they work in a different state than where their employer is located.
Independent contractor or employee determination
The first step in determining tax rules for someone working remotely is whether that individual is an employee or independent contractor. The distinction between the two classifications is based on the facts and circumstances of each taxpayer’s situation, however, the IRS looks at two important factors when distinguishing the two: control and relationship. Under the general rules, an individual is considered an independent contractor if the payer has the right to control only the result of the work and the individual has the authority as to how the work will be executed. If the payer has legal right to control how the services or work is performed, then the individual is an employee.
Defining “telecommuting” and “working remotely”
Sometimes, the terms “telecommuting” or “telework” and “working remotely” are used interchangeably—however, telecommuting means that an employee may work from home but also may perform some work on-site with the company some of the time. Teleworkers are usually located within the same geographic location as the company. Generally, teleworkers won’t face double tax issues unless they live and work on the border of two states and cross state lines.
“Remote work” or “working remotely” are used to describe employees who are not located in the same geographic location as the company. These employees could work either on a permanent or on a temporary basis.
Example: Company XYZ is based in Los Angeles, California. Tabitha also lives in Los Angeles and works from home four days per week and goes into the office for one day per week. Tabitha is telecommuting.
Regina lives in Miami, Florida also works for Company XYZ in Los Angeles. Regina works from her home in Florida home five days per week. Regina is a remote employee for the company.
Which U.S. states tax a remote worker’s income?
For remote workers, the question becomes which state will tax the individual. Generally, states either use the domicile or physical presence factors to determine which state employees pay taxes . Domicile is generally defined as the place where an individual decides to establish their home or permanent place of residence. Physical presence rules usually indicate a minimum amount of time an individual must be present in a state to be considered a resident.
Some states look to domicile and won’t consider physical presence—but each state has its own rules for residency so taxpayers must review the rules for their specific state to determine how they will be taxed when working remotely. If they are residents of a state, they are taxed on all sources of income no matter where derived.
Remote workers generally perform work in the state where they reside rather than where the company may be located. This generally means that the state the employee lives in can tax their income as a resident (if the state has personal income taxes).
Nonresident tax returns could be required when remote workers earn income outside of their state of residency
Generally, taxpayers are nonresidents of a state if they do not have a physical presence or domicile within a state. Usually, nonresidents of a state are only taxed on income that was earned within the nonresident state.
Example: Phillip lives in New York and would most likely be subject to New York taxes as a New York resident on his income for any work performed while working in Maine for some of the year. Depending on Maine’s filing requirements, Phillip could also be required to file a nonresident return or a part-year return with the state of Maine for any income that was earned during the year in Maine. Phillip could then qualify for a credit on his New York return for taxes paid to Maine on income taxed in both states.
Sometimes, a remote employee’s Form W-2 lists more than one state—their state of residence and another state where they work. In those instances, the employee may be required to file a nonresident tax return with the second state that was listed on the W-2. If a nonresident return is not required, an individual may still want file a nonresident return to get a refund for any withholding. It is always a best practice to check each individual state’s filing requirements.
Working remotely might negatively affect state taxes
Some states, such as New York, Delaware, Pennsylvania, and Nebraska, apply a “convenience versus necessary” test (or “convenience of employer” test) to determine if an employee is required to work from home, or if it is merely “convenient” for the employee to do so. If an employer is located in one of the “convenience of the employer” states, and the law determines the employee works from their home out of convenience rather than necessity, the employer’s state can tax the remote worker for income earned on days worked in the remote worker’s state. The remote worker’s resident state could also tax the same income, leading to double tax on the same wages. Note that each state implementing this test has its own rules for what qualifies as convenient or necessary.
For remote workers living in “no-income tax” states, the tax impact of working remotely for an employer outside of those states could have a fairly drastic impact. No-income tax states include:
- New Hampshire,
- South Dakota,
- Washington, and
Example: Jack, who is a resident of Florida, is an employee of ABC company based and operating out of New York. Jack performs all the work within an office in his home for ABC company for the entire year. The New York State Department of Taxation and Finance finds that Jack works out of his home office out of convenience, not out of necessity. As a result, Jack will be required to file a New York nonresident return, since the income earned will be sourced to New York. If Jack instead worked for a company located in a state without the convenience or necessity test, he may not be required to file any income tax returns with any state.
Reciprocal agreements can alleviate one state’s tax burden
In an effort to prevent double taxation, some states have reciprocal agreements with neighboring or bordering states. Under a reciprocal agreement two states agree to exempt taxation on work that may have been performed in the other. A taxpayer living in a state with a reciprocal agreement would not have to worry about filing a nonresident tax return for any work performed in a nonresident state. It is best practice to check if a state has a reciprocal agreement with any neighboring state and what sort of income is exempt. For example, many states with reciprocal agreements allow an exemption from tax only for compensation or wages, while other sources of income like self-employed income or gain from sale of property would be subject to tax in both the resident and nonresident state.
Example: Jill, who is a resident of New Jersey, is a remote employee for a company based and operating in Pennsylvania. Jill only has compensation from the employer in Pennsylvania and it’s reported to her on Form W-2. Under Pennsylvania’s “convenience of the employer” rules, Jill is found to earn income from Pennsylvania sources even though she performs all her work in New Jersey from home. Under the general rules, Jill would need to file a nonresident return with the Pennsylvania tax office for the income earned from Pennsylvania. However, Pennsylvania and New Jersey have a reciprocity agreement. Under the reciprocal agreement, any compensation earned by a New Jersey resident employed in Pennsylvania would not be subject to tax in Pennsylvania. Therefore, Jill would only need to file a tax return in New Jersey as a resident. She is exempt from filing a Pennsylvania return.
Working remotely doesn’t qualify for special tax deductions
With the implementation of TCJA, unreimbursed employee business expenses (including employees eligible for the home office business deduction) are no longer deductible. Only individuals who qualify as an Armed Forces reservist, qualified performing artist, fee-basis state or local government official, and employee with impairment-related work expenses are eligible to still claim any unreimbursed employee expenses on their return.
Prior to the implementation of the Tax Cuts and Jobs Act, taxpayers were eligible to claim a deduction for business use of their home. In order to qualify for the deduction, the taxpayer had to satisfy certain requirements.
We can help
The ability to work from home can make some jobs seem quite appealing. Despite the appeal, some employees may still worry about where they may owe tax and file returns when deciding on whether to accept remote position. Keep in mind that most employees are generally only taxed in the state in which the work was performed. Make an appointment today with one of our experts to find out how working remotely could affect your state tax returns.
For more information for taxpayers who cross borders for their business, check out this Insights article on artists, musicians, and makers.