COVID has changed the world of work. Here's how it's impacted your employees' taxes.
Since the onset of COVID-19, the world of work has changed drastically. Almost overnight, companies all over the world evacuated their physical offices and moved their entire operation to a completely virtual setting—and this situation isn’t likely to change any time soon. Research shows that 36.2 million Americans will be working remotely by 2025, an 87% increase from pre-pandemic levels.While 83% of employers say the shift to remote work has been successful for their company, the transition is far from over. The next phase for HR teams and company leaders is to figure out how to best support their employees in both hybrid and remote work settings. This can only be accomplished by understanding the new, unique challenges that come with working from home. One of these challenges is the topic of taxation. If you’ve tried Googling “remote workers and taxes,” you know there’s a lot of confusing, complex information out there about this topic. Your employees are also likely coming to you for financial guidance. That’s why we want to use this post to break down the most important tax-related issues to be aware of so you can better support your workforce—and to share recommendations to help you through this transitional period.
Tax day is right around the corner. However, if you’re like most HR teams, you’ve been so busy taking care of your employees during the pandemic that you haven’t had the headspace to think about the implications of remote work on their taxes this year—let alone plan for them in advance.While both federal and state governments have been taking a forgiving approach to taxes while COVID-19 is ongoing, it’s still important to understand the taxation process for remote workforces as soon as possible. This will help you make better business and people-related decisions moving forward and ensures that you’ve dotted your i’s and crossed your t’s by the time we return to normalcy.
As an employer, you may assume that you don’t need to worry about where your employees are working. After all, you haven’t moved the location of your offices. Unfortunately, this isn’t the case. When you have employees in different states, there’s a good chance that you may have tax obligations in those states—even if you don’t have a physical office located there. Specifically, there’s one question every remote company needs to be able to answer to understand their tax obligations: which states do we pay payroll taxes to? This is a seemingly simple question, but it’s one with a complicated response. However, to be able to answer it at all, it’s critical to know exactly where your employees are working because every state operates under different guidelines.For example: let’s say you have employees who live in California, where your office is located. But they decided to relocate to New York during the pandemic. This means you have to withhold income taxes for both states and may owe additional money. But if your employee moves from California to Arizona, you won’t have to worry about the additional withholdings due to the reciprocity agreement, which we’ll learn about later in the post.While many HR leaders assume they know the location of their workforce, the data shows this isn’t the case. 93% of HR professionals were confident they know where the majority of their employees are working, and 78% were confident their employees self-report when working in another state or country. However, only 33% of employees said they reported all those days, and 24% admitted reporting none at all.This discrepancy may result in errors in your tax reporting, which can lead to financial consequences for your business.
Make your reporting policies clear.Many of your employees may not be aware that they have to report their location to HR—especially if this is their first time working remotely. That’s why we encourage companies to update their existing policies to reflect the requirements in a remote environment and communicate these expectations to the rest of the organization.Proactively reach out to employees.Even after announcing the reporting requirements, it may not be realistic to expect every employee to take action. In this case, it may be beneficial for HR teams to proactively reach out to employees with a clear call to action—such as asking them to fill out a spreadsheet that documents where they’ve spent time in the last 12 months. While inconvenient, a general best practice is to have employees update this document with their location and how many days they spent in each one to help you determine the tax responsibilities in each state.
Once you understand how many of your employees are distributed and where they’re located, it’s time to start thinking about the tax implications of each state. This is where it gets tricky. Let’s return to the question we posed in the previous section: which states do we pay payroll taxes to?First, let’s clarify the definition of payroll taxes. Payroll taxes are the state and federal taxes that are paid on the wages, salaries, and tips of employees. There are generally two components of payroll taxes:
The latter category includes:
The state-level taxes are where things get complicated because every state operates under a different set of guidelines. Typically, most people work and live in the same state. In that case, taxation is simple: all taxes get paid to the state where your employee lives and works.But let’s say your employee works in one state and lives in another. In this scenario, your employee has to pay non-resident income taxes for the state in which they work and resident income taxes for the state in which they live—with a few exceptions we’ll illustrate below.The remote work situation adds a layer of complexity since an increasing number of employees are living and working in different places—not to mention that they may be moving around to more than one location. The more states an employee works in, the more complexity you’ll have to navigate. So while there’s unfortunately no one-size-fits-all answer to our original question, it may help to become familiar with the various guidelines states use to determine whether a company or employee will owe them taxes:
Nexus
When a company establishes nexus in a state, it essentially means they have a business presence there. This is significant because establishing nexus in a state requires registration and could subject the company to state payroll tax requirements and corporate income tax obligations. Traditionally, the mere physical presence of an employee in a different state could trigger nexus for a company. However, many states—such as Massachusetts and Pennsylvania—have relaxed this rule during the pandemic and said they will continue to do so until official work-from-home orders or states of emergency are in place. On the other hand, states like New York are continuing to enforce the physical presence rule since the state has a significant number of workers who commute from other neighboring areas.
First-day rule
This is a rule that states nonresident workers will owe state taxes from the very first day they start working outside their home state, even if their work there is temporary. This includes Alabama, Arkansas, Colorado, Connecticut, Delaware, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Rhode Island, and Vermont.
Waiting period
Other states have a waiting period, which allows nonresidents to earn income in the state for a specific period of time before subjecting that income to taxation. This waiting period can vary widely by state. This includes Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.
Earned income
Other states have an earned income threshold, which allows nonresidents to earn income in the state up to a certain amount before subjecting that income to taxation. This amount can vary widely by state. This includes California, Idaho, Minnesota, Oklahoma, Oregon, and Wisconsin.
Reciprocity
An agreement between two states that exempts employees from state and local taxes in their state of employment, which means they only need to pay the taxes of the state where they reside. This includes Arizona, District of Columbia, Illinois, Indiana, Iowa, Kentucky, Maryland, Michigan, Minnesota, Montana, New Jersey, North Dakota, Ohio, Pennsylvania, Virginia, West Virginia, Wisconsin.
No income tax
If an employee establishes residency in one of these states, they won’t owe income taxes. This includes Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.
Choose the right tools. Selecting the right tools can be a huge help when it comes to taxes. Payroll software, for example, can simplify the taxation process for HR teams by automatically withholding relevant state or local taxes, depending on the employee's state of residence. While HR teams will still have to understand the tax laws of each state and how they interact with one another, choosing the right tools can reduce some of the burden.
Consult with a financial expert. We also encourage companies to consult with financial experts throughout the tax process. As you can tell from this post, tax laws are incredibly complicated and can vary widely depending on your location, workforce, and even industry. To receive personalized guidance, seek out the support of a CPA or a tax lawyer, who are likely to be up-to-date on the latest tax codes.
What makes the world of taxes so complex is that it’s constantly changing. It’s also challenging to navigate because every state operates on a different set of regulations, rather than adhering to federal guidelines.Unfortunately, there’s still no federal legislation to regulate or provide clarity around the topic of remote work and taxation. One piece of relevant legislation is the Remote Worker Relief Act of 2020, which was introduced on August 14, 2020. According to Congresswoman Mary Gay Scanlon, who introduced the bill:
"This bill maintains the status quo for state income taxes and income earned by remote workers living in a tax jurisdiction different from their place of work for the 2020 tax year. This will prevent remote workers from bearing the onerous burden of determining which states they may owe taxes to.”
We encourage companies to pay attention to the progress of this bill, as it can have significant implications on both employees and employers. However, until there are federal regulations in place, most of your tax-related decisions will have to be based on the responses of every state, which are constantly changing.
Don’t assume flexibility. While many states have been loosening restrictions toward taxes during the pandemic, you shouldn’t assume that every local government will respond this way. We also encourage HR teams to get familiar with pre-COVID guidelines in every relevant state, as many of the current changes in guidelines won’t be applicable once states of emergencies are lifted.
Take advantage of existing resources. Thankfully, there are also a growing number of resources being published by accounting and law firms that are helping employers stay up-to-date. For instance, this tracker provides an overview of every state’s response to the issue of remote work and taxes during the pandemic. This document links to every state’s taxing authority website so you can easily identify ones that are relevant to your workforce.
It’s also important to make sure your employees are also being educated and supported regarding their finances during this transition period. A new survey conducted for the AICPA by The Harris Poll found that 55% of respondents who worked remotely this year aren’t aware of the potential tax consequences of not changing their state tax withholding to reflect where they worked remotely.This means many of your workers could be on the hook for unexpected tax payments, which could have negative financial implications for them. Here are a few recommendations on how to best support your employees during this time:
Educate your workforce. There are many creative ways to educate your employees about their upcoming taxes. You can invite a CPA to host a virtual Q&A session for your organization. Similarly, you can create materials that are customized to the needs of your employees. For example, consider surveying your employees to see where most of them are working and use that data to create a document that outlines the tax laws of the most popular states.
Make sure they don’t fall into common “tax traps.” In addition to becoming familiar with the tax implications of the states they live and work in, your employees should also be made aware of common “tax traps.” For instance, your workers may assume that since they’re remote, they’ll be able to deduct expenses for their home office. Unfortunately, this rule only applies to self-employed workers. These misconceptions can significantly impact how your employees prepare for taxes.
Provide personalized support. Of course, every employee’s financial situation looks slightly different. That’s why we recommend finding a way to give all your workers personalized support in this area. However, we totally empathize with the fact that you have your hands full as an HR team and may not be able to give each employee the level of personalized attention that they need to manage their finances.
That’s where Origin comes in. We provide your employees with access to unbiased and dedicated planners who will help them navigate their personalized financial journeys during this confusing time. Our all-in-one platform also makes it easy for your workforce to plan out and stay on top of their financial roadmap, so they can save for their taxes, as well as other goals, throughout the year.
If you want to learn how our holistic financial benefits platform can support your workforce, request a demo.
Please note that this guide is not to be taken as tax advice. Since tax rules are constantly changing and vary by location and industry, we encourage you to consult a qualified legal, tax, or accounting professional for specific guidance.
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