The Effects of Cross-Border Telecommuting on Personal Income Tax During the Pandemic
With working-from-home now a norm due to coronavirus restrictions on gatherings and travel, some workers have taken advantage of this relatively new freedom by deciding to move their home (and, subsequently, office) elsewhere. Some have moved to be with family who might need additional assistance, and others to be with friends. Still, either situation generates tax implications for those who cross into other taxing jurisdictions.
There are many socially desirable benefits of flexible working environment policies that extend beyond high employee morale and job satisfaction. In fact, working from home helps reduce carbon emissions and lower congestion on thoroughfares. But there are also personal costs associated with working from home, especially if your employer is in another state.
States apportion income for tax by using time spent in a jurisdiction as an apportionment factor. Using this method means if you worked 200 days in Texas, 42 days in Arizona and 10 in Georgia, you would apportion 79.5% of your income to Texas, 16.6% to Arizona and 3.9% to Georgia for income tax purposes. Physical apportionment of income allows for states to recoup costs from workers for the use of public services like infrastructure, such as roads and water lines, and public emergency services, such as police and fire protection.
Physical apportionment is, however, not the only method used to allocate income for tax purposes. The other method, largely criticized by tax practitioners, is to tax a person in their employer’s state regardless of where they perform the work, unless they cannot do their work in that state. The application of the convenience rule in this situation then means that if an employee’s job requires them to travel across state lines for their job, then they are not subject to tax in their home state because their change in their physical location is not convenience, but rather necessity.
Six states currently have rules mandating that income earned from sources within the state, regardless of the taxpayer’s current physical location, are taxed by that state. Some states, such as Massachusetts, have made administrative, regulatory decisions stating that the department of revenue will consider income earned through Massachusetts employers Massachusetts-sourced income.
Under these rules, that income would be subject to Massachusetts income tax even if the work is not performed inside the Commonwealth. In other words, Massachusetts will take a “snapshot” of working locations just before the pandemic and use that as the standard for the whole tax year. This decision represents a costly change for interstate telecommuters working in other states, but provides significant windfalls to the Commonwealth’s budget.
An example of this would be if a New York hedge fund employee spent the COVID-19-induced work-from-home mandates working from her Vermont mountain home instead of her midtown penthouse. The taxpayer changed her working location for her convenience, not for the necessity of the work. She would owe tax to Vermont due to her work site, and because of the location of her employer, she would also owe tax on her salary to New York. In this situation, the taxpayer’s income is double-taxed.
States are willing to help their taxpayers by giving a tax credit for taxes paid to other states on income included in their home state’s taxable income. Still, these credits have restrictions, usually mandating that they earn the income in the other state. Under these policies, our hedge fund manager would not be eligible for a Vermont tax credit for taxes paid to New York because she performed the work in Vermont at her home. Thus, the taxpayer receives tax bills from two states on the same income, resulting again in double taxation.
There are two possible scenarios when talking about working from home across state lines. There is either a convenience rule or there is not, and the tax difference between them is stark. With a convenience rule, the example hedge fund employee making $100,000 would be subject to both New York and Vermont taxes, totaling about $10,085. Without that rule, the hedge fund manager would only pay $4,627. Cross-state telecommuting is a tax issue that can potentially cost unsuspecting taxpayers thousands of dollars unexpectedly with little warning or recourse.
Figure 2:Tax Foundation calculations
In the example of the hedge fund employee, under current income apportionment rules between New York and Vermont, she would owe income tax to New York and Vermont without either state giving a credit for the other state. To say it a different way, telecommuting across state lines creates many issues with tax and income apportionment that the average, or even high-income, worker may not anticipate.
Some states have made reciprocity agreements with other states that outline who has taxing rights for income earned in either state. These agreements generally follow the idea that income is taxed in the home state rather than the place where the taxpayer works. This simplicity of taxing interstate employment makes tax compliance easier and cheaper for taxpayers and their employers.
The most used example of a reciprocity agreement is between Washington D.C., Virginia and Maryland, in which income is taxed only where the person lives. Notably, New York and New Jersey do not have any agreement as to the tax treatment of commuters to New York City. This is likely due to the fact that if New York agreed to tax only where the taxpayer lives, a large portion of revenue would be lost due to the high commuter population.
The Multi-State Worker Tax Fairness Act of 2020 (MSWTFA) was introduced in August to the U.S. House of Representatives by Rep. James Himes, D-Conn., for the third time since 2014. If enacted, the bill would limit the ability of states like New York and Massachusetts to impose a tax on employees wholly working in another state, forcing them to use more traditional income apportionment methods such as physical presence. The bill currently sits in the House Judiciary Committee and has been stalled since early August, with no sign of movement soon.
In the U.S. Senate this June, Sen. John Thune (R-SD) introduced the Remote and Mobile Worker Relief Act of 2020, which, similar to MSWTFA, would place limits on states’ ability to tax income solely due to the location of someone’s employer. This bill would signal a tide shift from giving states total autonomy in their tax systems to the federal government playing a larger role assisting the flow of interstate commerce.
Both of these proposed federal solutions would help alleviate the compliance issues that will certainly arise when taxpayers realize they did not correctly remit taxes from each paycheck to the proper tax authorities, and thus face an underpayment penalty. States would oppose any move to limit their taxing authority, especially now, when many states face huge budget shortfalls and are in search of new revenue.
There has been some talk that portions of these solutions may find their way into the possible round-two stimulus bill, but that remains to be seen.
Without some sort of congressional option, remote teleworkers are open to “outright double taxation,” according to Jared Walczak, vice president of state projects at Tax Foundation. Walczak said these aggressive tax policies work to raise revenue in the short term. Still, the long term provides large financial incentives for employers to set up in-state offices for remote employees, eliminating the cross-borders telecommuting, and subjecting them to only their home state’s income tax.
Even if Congress leaves the right to tax incomes of non-resident workers up to the states, there is merit to the idea of not allowing penalties for underpayment of those taxes. Penalties mainly serve to raise revenue rather than as their intended purpose of changing behavior. In the past, these penalties have induced high-income earners to make timely estimated tax payments, which help keep states’ budgets and cash flows steady throughout the year, but now more taxpayers will be subject to them. The penalty collections will increase overall revenue easily by 1-2%, with no added cost for enforcement, in Massachusetts based on current penalty rates for tax underpayment.
While both of these bills would certainly stand up to constitutional challenges under the commerce clause, they would not be popular with state legislators who can raise money by taxing non-residents, and who also happen not to have a vote in the affairs of the state. It’s politically expedient to tax those who do not have a voice or vote, such as non-resident workers telecommuting across state lines.
Jean-Baptiste Colbert once said that the goal of any new tax policy is to “pluck the goose as to obtain the largest number of feathers with the least possible amount of hissing,” and that is precisely what taxing non-residents do. While taxpayers may “hiss,” they do not have a vote, so the “hissing” is of little concern to lawmakers.
This arrangement of taxing non-resident income earners amounts to taxation without representation, something our country has dealt with in the past with notably violent results. While expectations of a violent revolt by high-earning taxpayers remain at all-time lows, states should consider how their tax policies might affect future businesses opening in their states, especially in times of exponential telecommuting growth. Instead of tea parties in the Hudson river, large companies may just move their headquarters across the river to New Jersey, which apportions income by physical presence, reminding lawmakers that their tax systems do not exist in a vacuum.
Some states think that long-arm tax statutes, such as the convenience of the employer rules, are unconstitutional. In March of 2019, Arizona filed a lawsuit against California for non-resident taxation of taxpayers without “minimum contacts” to create nexus, claiming it was violating the due process of its citizens. The court declined to hear the case, which is significant because the Supreme Court is the only venue for states to bring other states to court. In doing so, the court de facto sided with California, giving it the green light to continue taxing non-residents as they have been.
More recently, New Hampshire filed a lawsuit in the Supreme Court alleging that Massachusetts’ move to tax non-residents is unconstitutionally depriving its citizens of due process while also violating the sovereignty of the Granite State.
New Hampshire has a unique tax situation because it chooses to not tax wage income and only tax some investment income, which sets it apart from the Commonwealth of Massachusetts, according to a co-sponsor of the House MSWFTA bill, Rep. Chris Pappas (D-NH) The low-tax environment is the core of New Hampshire’s competitive advantages against Massachusetts, and taxing remote workers takes that away. And the state is willing to go to court to protect that advantage.
New Hampshire Republican Gov. Chris Sununu said during a press conference, “Massachusetts cannot balance its budget on the backs of our citizens and punish our workers for working from home to keep themselves, their families, and those around them safe. We are going to fight this unconstitutional attempt to tax our citizens every step of the way, and we are going to win."
The prospects of victory for New Hampshire are grim due to the Supreme Court’s refusal to hear the Arizona case with very similar foundations. When asked for comment on the status of talks and expectations for an out between the two states, neither the New Hampshire nor Massachusetts state revenue departments provided comment.
The future of telework taxation will be established in the coming months, with courts weighing in on the constitutionality of long-arm tax statutes, said Christina Rice, Director of Boston University School of law’s graduate tax program. The precedents set by courts in telecommuting taxation will also affect other tax areas such as the standards for corporate tax nexus. Some states use payroll as a factor in determining nexus status and required filing of corporate income tax returns in the state.
Coronavirus has changed how companies look for talent, no longer limiting them to the geographic area in which they usually operate, though looking across the whole country for talent has issues of its own, such as tax implications. The current state of the pandemic and telecommuting tax policies is grim. Without federal solutions, our economy — and individuals who participate therein — may suffer.
Maxwell James directly reported to Jared Walczak, Vice President of State Projects, during a summer 2020 internship at Tax Foundation. Walczak was informed that the interview would be on the record.