One of the most notable effects of the pandemic has been the increase in remote working or “telework” as it has become known. This has caught many governments unprepared not least in relation to how work and services are taxed. Many workers and employers have also been caught unaware of the implications of working from different locations on their tax liabilities.
Take the example of a contingent worker in IT who lives in state A and used to commute to work in state B. When the pandemic struck, they started working from home in state A and have little prospect of returning to their office in state B any time soon. The individual may be liable for income tax earned in State B as well as state A. Their staffing agency employer also has state income tax withholding obligations, but which state do they pay tax to and should they be billing their client company a different rate of tax now?
Commuting workers. New York, Massachusetts and Pennsylvania, which have numerous “out of state” workers who commute from neighboring states, have maintained the status quo during the pandemic. Their approach has been to treat individuals who commuted into work before the pandemic, as still working in the office, even though they are working from another state. Some states have reciprocity agreements with their neighbors to avoid taxing workers’ income twice. Maryland, Pennsylvania, Virginia, West Virginia and Washington, D.C., have such an agreement in place, as do Pennsylvania and New Jersey.
Staffing firms and employers must also now consider whether the presence of employees in states where there is no bona fide company office creates tax obligations for a variety of taxes, not just employment taxes. In other words, do telecommuters create nexus for the company?
Tax implications. The term “nexus” refers to the level of connection that an out-of-state company must establish in a state before it becomes subject to that state’s tax laws and jurisdiction. The US Constitution requires a minimum level of connection between the state and the company or a transaction before the state can impose a tax without burdening interstate commerce. The 2018 US Supreme Court decision in South Dakota v. Wayfair made clear that the minimum contact requirement could be met even without physical presence in the state. It is enough for a business to have customers in that state.
Sales tax is one of the additional taxes that may be incurred due to the remote working of employees and contractors. If the IT contingent worker in the example above is a freelance independent contractor, their services may attract sales tax depending on whether the work they are doing for the client is a taxable service in their home state, state A.
Sales tax rules are complex, and rates vary from state to state, and in some cases locally. Some states will tax all services except for specific exemptions, while others tax only specified services. Five US states — New Hampshire, Oregon, Montana, Alaska and Delaware — do not impose any general, state-wide sales tax on goods or services. Four — Hawaii, South Dakota, New Mexico and West Virginia — tax services by default, with exceptions only for services specifically exempted in the law. Of the remaining 41 states, every one taxes a different set of services, making it difficult for service businesses to understand which states’ laws require them to file a return, as well as which specific elements of their services are taxable.
When it comes to permanent placement and temporary staffing arrangements, 12 states plus the District of Columbia impose a sales tax on staffing services: Connecticut, Delaware, Hawaii, Iowa, New Mexico, New York, Ohio, Pennsylvania, South Dakota, Tennessee, Washington and West Virginia. Some states charge sales tax on the mark-up, others on the total fee.
Jurisdiction. The jurisdiction (state, county and city) that has the legal authority to tax a transaction depends on the jurisdiction in which a sale of taxable services occurs. This is known as “situs” — literally meaning position or site. In some states, for example, a single employee working in the state can trigger sales and use tax collection obligations for their employer, even if the company does not have any other physical presence in the state.
If a contingent employee of a staffing firm temporarily relocated to one of these 13 states to work remotely for a buyer during the pandemic, the staffing firm may be required to collect sales tax from the buyer. If the staffing firm fails to collect and remit the tax, the state can impose the tax directly on the staffing firm along with penalties and interest for failure to collect and remit the tax.
A few states have issued guidance temporarily waiving sales and use tax consequences of workers who are temporarily forced to telecommute from the state due to Covid-19, but most have not.
As government orders are lifted and/or state and local authorities’ temporary relief expires, companies should continue to monitor the work locations of their employees to assess potential exposure to taxes and obligations to withhold taxes.
If companies are considering a long-term transition to a remote workforce, tax advice is recommended to manage any potential risk.