The year
2020 has brought us a new state tax issue.
To be fair, the
issue is not totally new, but it has taken on importance with stay-at-home
mandates.
Here is the issue:
You work in one state but live in another. Which state gets to tax you when you
are working from home?
Let’s start
with the general rule: state taxation belongs to the state where the employee
performs services, not the state where the employee resides. The concept is
referred to as “sourcing,” and it is the same reason a state can tax you if you
have rental real estate there.
Let’s follow
that with the first exception: states can agree to not follow the general rule.
Ohio, for example, has a reciprocal agreement with Kentucky. The agreement
provides that an employee will be taxed by his/her state of residence, not by the
state where the employee works. A Kentucky resident working in Ohio, for
example, will be taxed by Kentucky and not by Ohio.
Let’s pull
away from the Cincinnati tristate area, however. That reciprocal agreement makes
too much sense.
We need two other
states: let’s use Iowa and Missouri.
One lives in
Iowa and commutes to Missouri. Both states have an individual income tax. We
have 2020, COVID and stay-at-home. An employee of a Missouri employer works
from home, with home being Iowa.
Which state
gets to tax?
This one is
simple. Iowa.
Why?
Because both
states have the same rule: the state of residence gets to tax a telecommuter.
So where is
the issue in this area?
With states
that are … less reasonable … than Iowa and Missouri.
Let’s go to Captain
Obvious: New York.
New York has
a “convenience of the employer” addendum to the above discussion. Under this
rule, New York asks why the employee is working remotely: is it for the
convenience of the employer, or is it for the convenience of the employee? The
tax consequence varies depending on the answer.
* If for the convenience of the (New York) employer, then the employee’s state of residence has the first right to tax.
* If for the convenience of the (nonresident) employee, then New York has the first right to tax.
We for
example have a Tennessee client with a New York employer who walked into this
issue. He lives and works in Memphis, infrequently travelling to New York. We
were able to resolve the matter, but New York initially went after him rather
aggressively.
How does New
York’s rule work with 2020 and COVID?
It doesn’t.
All those employees
not commuting to New York were very much observing the convenience of their
employer.
Clearly, this
was an unacceptable answer to New York.
Let’s change
the rule, said New York: the employee’s “assigned or primary” location will now
control. If my accounting office was located in New York, for example, that
would be my “assigned or primary” office and New York could tax me, no matter
where I was.
How could I
avoid that result? I would need to have my employer open a bona fide office
where I lived. Some people could do that. Most could not.
Yessir.
There is no evolving
tax doctrine here. This is ad hoc and reactive taxation, with much caprice,
little constancy and the sense that New York will say and do whatever to lift your
wallet.
There are
few other states that follow this “convenience” rule: Pennsylvania, Delaware
and New Jersey come to mind. It is more convenient for them to tax you than not
to tax you, to reword the rule.
COVID
introduced us to two more states feuding over the taxation of telecommuters:
Massachusetts and New Hampshire. Massachusetts decreed that any employee who
began working outside the state for “pandemic-related” circumstances would
continue to be subject to Massachusetts income tax.
It is the
same issue as New York, one might initially think. New Hampshire will allow a
tax credit for the tax paid Massachusetts. The accounting fee goes up, but it
works out in the end, right?
Nope.
Why?
New
Hampshire does not tax W-2 income.
How do
states like Massachusetts or New York justify their behavior?
There is an
argument: Massachusetts and New York have roads, infrastructure, schools,
universities, hospitals and so forth that attracted employers to locate there. Their
tax is a fair and appropriate levy for providing and sustaining an environment which
allows a person to be employed.
Got it.
Don’t buy
it.
I grew up in
Florida, which does not have an individual income tax. Somehow the state nonetheless has roads,
infrastructure, schools, universities, hospitals and so forth. The only explanation must be divine
intervention, it appears.
Additionally,
if I lived in New Hampshire – and worked from there – I might prefer that my
taxes go to New Hampshire. I after all would be using its roads,
infrastructure, schools, universities, hospitals and so on, putting little – or
no – demand on Massachusetts. I might in fact be quite pleased to not commute
into Massachusetts regularly, if it all. It seems grotesque that Massachusetts will chase me across the fruited plains just because I need a job.
New
Hampshire has filed a complaint against Massachusetts with the Supreme Court. The
argument is rather simple: Massachusetts is infringing by imposing its tax on
New Hampshire residents working in New Hampshire. Interestingly, Connecticut and New Jersey have
filed amicus (“friend of the court”) briefs supporting New Hampshire’s position.
Their beef is with New York and not Massachusetts, but they are clearly
interested in the issue.
I personally
expect the expansion and growing acceptance of telecommuting to be a permanent
employment change as we come out of COVID and its attendant restrictions. With that
as context, the treatment of telecommuting may well be one of the “next big
things” in taxation.
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