State Taxation of Telecommuting

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.

UberEats and Employer-Provided Lunches

It is 50 pages long. This is not the time of year for me to read this in detail.

I am referring to an IRS Technical Advice Memorandum. A TAM means that a taxpayer is under examination and the revenue agent has a question. The TAM answers the question.

This one has to do with excluding meals as income to employees when the meals are for the “convenience of the employer.”

I guess I long ago selected the wrong profession for this to be an issue. The instances have been few over the years where an employer has regularly brought in dinner during busy season. I had one employer who would do so on Tuesdays and Thursdays, but the offset was working until 9 p.m. or later. As I recall, one virtually needed a papal decree to deviate from their policies, and they had policies like the Colonel has chicken. At this age and stage, I would not even consider working for them, but at the time I was young and dumb.

The classic “convenience of the employer” example is a fireman: you have to be around in case of emergencies. There are other common reasons:

·      To protect employees due to unsafe conditions surrounding the taxpayer’s business premises;

·      Because employees cannot secure a meal within a reasonable meal period;

·      Because the demands of the employees' job functions allow them to take only a short meal break.

What has exacerbated the issue is not your job or mine, but the Googles and Microsofts of the world. For example, Google’s headquarter in Mountain View, California has over 15 cafeterias. Not to be overshadowed, Microsoft in Redmond, Washington has over two dozen. Why would one even bother to go to a grocery store?

Not my world. Not my reality.

The “reasonable meal period” has generally meant that there are limited dining options nearby. I have a family member who works at a nuclear facility. I do not know, but I would expect options thin-out the closer you get to said facility. That reasonable meal period is likely legit in his case.

The TAM is presented in question and answer form. Here is one of the answers:

While the availability of meal delivery is not determinative in every analysis concerning …, especially in situations where delivery options are limited, meal delivery should be a consideration in determining whether an employer qualifies under this regulation and generally when evaluating other business reasons proffered by employers as support for providing meals for the “convenience of the employer” under section 119.

So the IRS is working to incorporate the rising popularity of GrubHub and UberEats into the taxation of employer-provided meals. Wow, if you practice long enough…

I am not too worried about it, other than prompting a chuckle. Why? Because here at CTG command-center we do not provide the occasional lunch because of limited dining opportunities. Rather we bring-in lunch because of in-house training (as an example), and we want everyone there.

Think about it: we give you a sandwich and you get to hear me talk about taxes and watching paint dry.

I suspect you would rather just buy your own lunch.

A Condo Association, Dogs Running Wild and An Office In Home

This time we are talking about an office-in-home. Many of us have one, but few of us can actually claim a tax deduction for it.

The office-in-home deduction has five main rules, two of which are highly specialized. The remaining three require one to:

1. Use the office exclusively and regularly as a principal place of business
2. Use the office exclusively and regularly as a place to meet or deal with patients, clients or customers in the normal course of business
3. Use the office in connection with a trade or business – but only if the office is a separate structure

If you are an employee, then you are in the trade or business of being an employee. If your office is in a separate structure, you are home-free under test (3). 

OBSERVATION: I suppose a converted, oversized shed could meet this test.   

I have a CPA friend who practices out of her basement. She would qualify under test (2), as she regularly meets with her clients there. I however almost always meet clients either at their office or mine, so I would not qualify.

That leaves us with test (1), which is an almost impossible standard to meet if one has an office elsewhere. Fortunately there was a Supreme Court decision a number of years ago (Soliman), which allowed one to consider administrative or management duties for purposes of this test.  

Soliman was an anesthesiologist, and the three hospitals where he worked did not provide him with an office. He used a spare bedroom for work-related activities, such as contacting patients and billing. The IRS had previously taken a very hard line with test (1) and denied the deduction. The IRS reasoned that Soliman’s job was to put people to sleep, and he did that job at the hospital. This meant that the hospital was his “principal” place of business.  The IRS was not going to be persuaded otherwise, at least until the Supreme Court told them to knock it off and allow Soliman his deduction.

Great. So I can do administrative work at home – such as scheduling or billing – and have my office qualify for a deduction, right?

Not so fast.

There are two more tests if one is an employee. The one that concerns us is the requirement that the office be for the convenience of the employer.

Those words sound innocuous, but they are not.

For most of us, having an office at home is for our convenience. In fact, the IRS takes this farther, arguing that – if your employer provides you with an office – then it is virtually impossible for the home office to be for the employer’s convenience.  The IRS reasons that the employer would not care if you showed up, as it had an office waiting. There are some exceptions, such as telecommuting or requiring work hours when the office is closed, but you get the idea. For the vast majority of employees, one cannot get past that convenience-of-employer test.

What if one is self-employed? Forget the convenience test. There is no employer.

Let’s look at McMillan v Commissioner. There will be a quiz at the end.

Denise McMillan had a couple of things going on, but what we are interested in is her home office. She was self-employed.

She claimed an office-in-home deduction on her 2009 return. I am not certain of her housing situation, but her office was 50% of her home. I cannot easily visualize how this is possible, especially given the requirement that the office space not be used for any other purpose. That is a lot of space that she is not using for another purpose – like living there.

She lived in a condo. She had gotten into it with the homeowners association over construction defects related to mold and noise, dogs running wild, dogs barking incessantly and leaving dog memorabilia as dogs will when running wild and barking nonstop.

The condo association would do nothing, so she sued them.

The condo association – highlighting the quality of its Board – sued her back.

Wow, send me a flyer so I can consider buying at this bus station to paradise.

All in all, she was out over $26 thousand in legal fees and expenses.

And she deducted 50% of them through her office-in-home deduction.

QUIZ: Is this a valid tax deduction?

She sued because of events which were interfering with her use and enjoyment of her property.  Had this property been exclusively her residence, the conversation would be over. But one-half of it was being used for business purposes.

She next had to show that the litigation also had an effect on her business activity.

 QUESTION: Have you decided yet?

The Court observed that she was suing over noise, animal waste and similar issues. She argued that they were affecting her ability to work. Makes sense to me.

The IRS did not challenge her argument. 

NOTE: My hunch is that the IRS was relying upon an origin-of-claim doctrine. The lawsuit originated from a personal asset – her residence – so the tax consequences therefrom should remain personal. In this case, personal means nondeductible.

Since the IRS did not challenge, the Court could not – or would not - conclude that there was no effect on her ability to work.

The IRS had not challenged the 50% percentage either.

So the Court decided that she was entitled to a tax deduction for 50% of her legal expenses.

By the way, how did you answer?

Silicon Valley Cafeterias And Tax-Free Meals

I have a friend who lives and works on the north side of Cincinnati (or as we south-of-the-river-residents call it: “Ohio”). He works for significant company, and one of the perks is a company cafeteria. The cafeteria provides breakfast, should one choose, and of course it provides lunch. Free.

I admit I am a bit envious.

In this day and age when just about everything is taxed – at least once – you may wonder how this can happen. It has to do with Code Section 119:

(a) Meals and lodging furnished to employee, his spouse, and his dependents, pursuant to employment

There shall be excluded from gross income of an employee the value of any meals or lodging furnished to him, his spouse, or any of his dependents by or on behalf of his employer for the convenience of the employer, but only if—

(1)     in the case of meals, the meals are furnished on the business premises of the employer

                                                                     

How did this provision come to be?

It officially entered the Code in 1954, although employers were already taking the deduction (and employees excluding the income) under administrative and judicial decisions.  Prior to 1954 there was some inconsistency on what was required for the employee to omit the income. Sometimes the courts focused exclusively on the convenience of the employer. Other times the courts would look at whether there was a compensatory reason for the meal. Depending on the focus, they could arrive at different answers, of course.

So Congress stepped-in in 1954 and gave us Section 119. There were differences between the House and Senate bills (The House did not want a convenience-of-the-employer test, but the Senate did). Both House and Senate booted out the issue of “compensatory reason.” If it were primarily for the convenience of the employer, then the meals were free. Whether the employee considered it compensatory was beside the point.

Let’s use an extreme example to understand what Congress was after. In Olkjer, for example, the taxpayer was employed at a remote location in Greenland. The employer provided meals (and, in this case, lodging also) because there was nowhere else to go.

And there any number of examples like that. Think of emergency room personnel. Could they hypothetically get in a car and go to a restaurant for lunch? Of course they could. It would not serve the hospital’s needs, however, and hence they are required to stay on premises. The same can be said for casino workers.

Fast forward a few decades and we now have Silicon Valley. Take Google, for example. If you work at the Googleplex you can eat breakfast, lunch and dinner for free. I recall that the personal chef for the Grateful Dead was one of the early chefs at Google. These companies prey on each other’s chefs, too. Facebook hired a chef away from Google, for example. Facebook now serves Thai-spiced cilantro chicken and salmon with red curry sauce. Their chef will also prepare a special meal as an employee award or recognition. These meals can be quite upscale, featuring seven courses on white tablecloth.

No doubt Section 119 has come a long way from what Congress was thinking back in 1954.

And there is the rub.

In 2013 the Wall Street Journal published an article on these cafeterias, including the question whether the provision of gourmet-level meals were intended to be tax-free. Spring forward a year or so and the IRS has included the issue in their 2014-2015 Priority Guidance Plan. It appears the IRS is shifting resources to develop tax lines-of-reasoning requiring such benefits be reported as taxable compensation to employees.

How? Actually, the direction is fairly straightforward. The IRS will challenge the perk as not being “primarily” for the convenience of the employer. They cannot challenge whether there is a “compensatory” reason, as the reports to the 1954 tax Code makes it clear that Congress was not concerned with that issue.

The companies of course argue that such perks are “primarily” for their convenience. How?

           

·        Encourage employees to arrive early

·        Encourage employees to stay late

·        Employees do not waste time going out to eat

·        Maximize collaboration opportunities, as employees eat together rather than taking individual cars and dining alone elsewhere

·        Help retain people and foster employee trust

·        Help attract prospective employees

You must admit, the companies have a point. My hunch is that the IRS will restrict the definition of “convenience” to require a closer connection between the cafeteria perk and the alleged convenience.

What do I think? I have been in tax practice long enough to see provisions come into the tax Code, and then see practitioners take said provisions into places and distances that Congress or the IRS never intended. There is uproar, and Congress or the IRS then cracks-down. The practitioners regroup, study tape, develop new game plans and all parties eventually take the field again for the next game. It is just the wheel and rhythm of tax law and practice.

I suspect the same will happen here.

I have over the years worked unreasonable hours, and many (not all, mind you) CPA firms will make some provision for their staff during busy season. These meals have been tax-free, as the impetus for the meal was exclusively for the convenience of the CPA firm (as far as I was concerned). There was nothing there that approached this level, however.

But then, Google and Twitter and companies like them have taken this provision into places and distances that Congress likely never intended.

I admit I am a bit envious.

Change in Office-In-Home Rules (Starting Next Year)

The IRS surprised me yesterday.

Do you ever work from home? Let me phrase it differently: do you have an office-in-home, as the IRS defines the term?

I have an office at home and I work from home occasionally (I try to keep my workload at the office). I do not however have an office-in-home for tax purposes. Why? My office would have to meet one of three criteria to rise to a tax deduction:

 

(1)   My office–in-home is the principal place of my trade or business

·        I will not meet this test as I have an office in Cincinnati.

(2)   A place where I meet with clients, patients or customers in the normal course of my business

·        Granted, I do a lot of my work on a computer or over a cell phone, but I primarily meet with clients at my office in Cincinnati.

(3)   I work from home for the convenience of my employer

·        The IRS has interpreted this test to mean that the employer does not provide the employee with an office, so the employee – needing a place to work – has one in his/her home. If the employer does provide an office, one will have an almost insurmountable challenge in meeting this test. There may be some latitude in a hoteling situation, but you get the idea. I will likely fail this test.

Let’s say that you meet one of the three tests. Perhaps you freelance as a second job. That freelancing may qualify you for the office-in-home deduction. We meet for preparation of your taxes. We discuss expenses related to your office-in-home: the interest, taxes, utilities, insurance, security and etc. We calculate the depreciation. We then have to prorate between the personal use of your home and the business use. All the while, I am remembering that just putting this deduction on your return increases your odds of audit selection.

So the IRS came out yesterday and provided a simplified rule for an office-in-home. They will spot you $5 per square foot – up to 300 square feet - for your office. No depreciation. No proration of expenses. There is a downside: you will not be able to carryover excess office-in-home deductions under this method. There is an upside: you can elect annually which method you want to use. Obviously if you have more than 300 square feet, or your expenses run more than $5 per square foot, you will probably elect to use actual expenses.

• NOTE: The simplified election starts with tax year 2013. We cannot use this election when preparing your 2012 individual tax return, unfortunately.

By the way, let me clarify what the IRS means by office-in-home. Any direct expenses you have – say a camera or film for a photographer or payroll for an employee – are not considered office-in-home expenses. An alternate phrasing is that these expenses would be avoidable if you did not engage in the business activity. The office-in-home expenses are indirect and unavoidable. That is, you would still have the mortgage, taxes, and insurance whether you freelanced or not.