Working remotely is a necessity for many during the coronavirus pandemic. Some employees may not even have a choice in the matter. In September 2020, 36.4% of adults said they are living in a household where at least one person is completing some or all of their work from home instead of at the in-person location of their employer as a result of COVID-19.
With this forced remote-work situation comes the possibility of a few tax ramifications. The federal government doesn’t care too much where you work—but states do.
You might not feel any tax impact at all from relocating to your home office—and, in fact, you probably won’t if you happen to live in the same state where your employer is located. But things can get complicated if you live in a different state from the employer’s. And it’s not just employees who are affected by this change. Employers bear the brunt of headaches associated with tax compliance when they employ remote workers.
Luckily, as of Sept. 1, 2020, 13 states have waived physical nexus requirements for their employees’ states of residence in the face of the pandemic. If you’re one of the many people in the U.S. working from home or somewhere else remotely, it’s important to know how your state taxes could be impacted.
- The state income taxes you pay may be affected if you’re working remotely during the pandemic in a state that’s different from where your employer is located.
- This could result in double taxation.
- Employees should receive a tax credit from their state of residence for any income taxes paid to another state.
- If the money is still withheld, you’ll have to wait for a tax refund to get it back.
Income Taxes for Remote Workers
Remote workers can find that they have to pay income tax to two states on the same income if they don’t live in the same state where their employer is located. You might live in New Jersey, but have been commuting to New York for many years to earn a living. Now you’re working from your home desk in New Jersey. Taxes should be withheld from your pay for both states, and you’ll have to file two separate state tax returns.
Numerous legal factors and tax provisions come into play here. The Supreme Court ruled in 2015 in Comptroller of the Treasury of Maryland v. Wynne that two states cannot tax the same income twice. In theory, at least, states are supposed to offer residents credits on their tax returns for taxes paid to another state, so the taxpayers essentially get that money back. But there’s a gray area here known as the “convenience rule” that conflicts with this federal decision.
Some states have tax reciprocity with each other, and this adds yet another wrinkle to the situation. Workers won’t be taxed by their work state if it has reciprocity with their state of residence. No tax credit is necessary.
The convenience rule states that an employee is liable for paying income tax to their employer’s state if they’re working remotely because it’s convenient, not because their employer requires it. This rule can be met and ignored in many cases during the coronavirus pandemic because employees are being required to work from home. But they might be liable for double taxation if they’re working remotely because they’re concerned about exposing themselves to the virus, or for other personal reasons.
Workers who have two states’ income taxes being withheld from their pay should still receive a tax credit from their resident state for the amount paid to their employer’s state. Another option is to file a nonresident tax return there to get the money back. Either way, employees will have to wait for a potential tax refund to recoup that cash.
These rules might also come into play more and more frequently going forward because many businesses have found that having employees work remotely is more cost-efficient overall.
That Elusive Home Office Deduction
You might be thinking that you could come out ahead taxwise if you claim a home office deduction on your 2020 federal tax return because you’ve been forced to work from home. Unfortunately, you can’t do that, thanks to the Tax Cuts and Jobs Act (TCJA).
Employees used to be able to claim a deduction for expenses associated with their home offices if they worked there because it was convenient for their employer. This was a miscellaneous itemized deduction for those who were not independent contractors or self-employed. But the TCJA eliminated miscellaneous itemized deductions from the federal tax code in 2018—through at least 2025, when this legislation potentially expires.
The IRS states unequivocally that “employees are not eligible to claim the home office deduction.” Only independent contractors and self-employed taxpayers can do so as of 2020.
Employers’ Taxes and Their Responsibilities
Employers can be more severely affected by all these overlapping rules. They’re faced with the challenge of determining tax rules in multiple states—their own, and those where any of their remote employees are living and working. Yet another rule comes into play here. It’s known as “physical nexus.”
A business has physical nexus in a state other than its own when it pays an employee who performs work there. This normally would be the worker’s home state during the 2020 pandemic, but the rule would also apply if an employee lived right next door to the business but went to a location in another state to perform their work for the company there.
Employers can find that they have a physical nexus with multiple states if their employees perform work from home in those states. This requires that businesses abide by the other states’ tax and labor laws in addition to their own.
Physical nexus doesn’t apply only to income tax, but also to gross receipt taxes and sales-and-use taxes as well. It can also affect issues such as unemployment and workers’ compensation insurance.
Employers would be required to begin tax withholding for their employees’ states of residence as well if they were performing work out of state. Some states are temporarily waiving these physical nexus requirements in the face of the pandemic, however. This status was in effect in 13 states as of Sept. 1, 2020:
- New Jersey
- Rhode Island
- South Carolina
If you’re an employer, check with a tax professional to determine the physical nexus status in your employees’ states if any are performing work for you remotely. You should also keep up to date with your workers as to where they’re living during this time. Don’t assume they’re still living where they were before the pandemic.