Safe Harbors And Warring States: The Tax Troubles Of Remote Work

As a host of employees shifted to remote work during the Covid-19 pandemic, it’s a good bet few thought about the tax implications of the change, being more concerned with staying healthy and keeping the kids out of the workspace during Zoom meetings.

And though many predict telecommuting is here to stay after this crisis is nothing but a foul memory, discussions have centered on issues like morale and the loss of corporate culture.

The trend’s biggest repercussions, however, might very well be on taxes. 

“The pandemic itself and the remote-work environment have had significant impacts on state and local taxation,” according to Keith Eisenstein, a state-and-local tax principal with Ernst & Young LLP and chair of the Practising Law Institute’s Hot Topics in State and Local Tax program. “Whether it’s income tax and the nexus impact caused by people now working from home, to employment tax considerations increasing the administrative burden, it’s clear the shift towards remote work has greatly influenced state and local taxes.”

“The prospective impact may be even greater,” Eisenstein said, as temporary pandemic “safe harbor” provisions fade away.

The two big aspects of these safe harbor provisions, he said, are “exemption from withholding and exemption from corporate income tax.”

Many states agreed to exempt companies from corporate income tax and the necessity to withhold taxes for their employees if the companies’ only contact with the state during 2020 was people working at home because of the pandemic. Many of these safe harbor provisions are still in effect as the state of emergency has dragged on.

“Eventually, the states are not going to give exemptions anymore,” Eisenstein said. The question is: What happens if not all those employees return to their daily commute?

Companies need to be aware of the potential tax issues. They may also face problems with double taxation and clawbacks of any incentives they might have received to place their offices in a certain locale. 

The Battle in New England

In October 2020, New Hampshire entered a motion for leave to file a complaint with the U.S. Supreme Court against Massachusetts alleging that the latter state’s new tax regulation is unconstitutional. The motion demonstrates what can happen when employees who used to commute to another state to work in an office now work at home. The Supreme Court has original jurisdiction over conflicts between states, although it hasn’t indicated whether it will accept the case. In January, the court requested a brief from the Solicitor General on the federal government’s view of the issue.

The focus of New Hampshire’s grievance is an emergency regulation adopted by Massachusetts in April 2020 that “maintained the status quo for personal income tax withholding purposes,” according to a brief filed by that state. The regulation means that non-resident employees who worked in-state before the pandemic “would continue to be taxed in the same proportion as during the immediate pre-pandemic period, regardless whether they continued commuting to the Commonwealth to do their work, or performed the same work remotely from home or another location, or varied their location by the day or week.”

New Hampshire objects to its citizens having to pay income tax to its neighboring state at all.

“Massachusetts has radically redefined what constitutes Massachusetts-sourced income in order to tax earnings for work performed entirely outside its borders. This does not maintain the status quo. It upends it,” the Granite State said in its reply brief.

As the Covid-19 emergency lingered, Massachusetts extended its rule several times, leading New Hampshire to fear it will become permanent. The state argues the Supreme Court needs to take up this dispute because “this is an issue of national importance certain to survive the current pandemic.” Considering the amicus briefs filed by more than 15 states and several organizations, plenty of people agree. 

Among other things, New Hampshire claims that the regulation is unconstitutional. While Massachusetts makes a few procedural arguments in its brief as to why the petition should be rejected, it also claims its regulation passes muster under the dormant Commerce Clause test laid out in the 1977 case Complete Auto Transit, Inc. v. Brady. The regulation, it says, is “(1) ‘applied to an activity with a substantial nexus with the taxing State,’ (2) is ‘fairly apportioned,’ (3) ‘does not discriminate against interstate commerce,’ and (4) ‘is fairly related to the services provided by the State.’”

Eisenstein noted that Massachusetts is essentially making a “convenience of the employer” argument similar to one New York made successfully back in 2003 in the Matter of Zelinsky v. Tax Appeals Tribunal. The gist of this argument is that employees are “really working from home for their own convenience, not because the employer needs them to work at home.”

But for Covid-19, these employees would likely be working in the office. Therefore, the state says, we are going to tax you like you’re still going into the office. Obviously, considering government shut down orders, this is an interesting approach, but soon these matters will no longer be about the pandemic.

Such cross-border taxation issues “will take some time to shake out,” Eisenstein said. “We’re in quite a bit of a remote-work environment. That’s going to continue.”

As a result, there has been a renewed effort to get legislation through Congress, like the Mobile Workforce State Income Tax Simplification Act of 2020 introduced in February.

Eisenstein said these bills, in one form or another, have been before Congress for many years, but it may take the new reality of telecommuting to get it done. “These federal bills are basically trying to get a safe harbor provision passed that says you can’t tax these employees if they’re in your state for less than 30 days a year,” he said.

Credits and Incentives

Another thorny tax problem that may take some time to shake out is the consequences “for companies who pursued credits and incentives when they established their headquarters or another new location,” Eisenstein said. Often, to qualify for such incentives, a company must guarantee a certain number of jobs will be created and agree to certain amount of capital expenditure. With the pandemic, because so many jobs have gone remote, these jobs may no longer be located in the state, city or town that offered the incentive, meaning the company is not meeting its obligations under the incentive program.

“There’s a lot of nuance in the credit and incentive area,” Eisenstein said. Companies may be forced to exit or renegotiate the incentive plan, and municipalities may try to recapture the benefits provided.

Some states have already addressed the problem, at least in terms of the pandemic. For instance, Nebraska offered guidance last April regarding its incentive plan, called the Nebraska Advantage Act. The act states that “all or a portion of tax incentive previously earned shall be recaptured if the project-holder fails to meet the required levels of employment or investment by the end of the attainment period or fails to maintain those levels for the entire entitlement period.”

The act also includes a force majeure provision, however, which states that “the recapture will not occur if the failure to maintain the required level of employment or investment was caused by an act of God or a national emergency.”

Given that the federal government declared the pandemic a national emergency in March of last year, Nebraska saw fit to let its “project-holders” off the hook, so long as they can demonstrate that the emergency was the “triggering event” that caused their failure.

Of course, just because some states handle the situation this way, does not mean they all will, especially if they are money-starved as a result of the pandemic. It remains to be seen if “localities are going to be amenable to providing relief or if there will there be enforcement of clawback provisions,” Eisenstein said. 

In addition, if remote workers do not return to the office post-pandemic, resulting in a company’s failure to meet its employment-level requirements, the company is likely to have some trouble claiming the pandemic as the cause.

One thing seems sure: The taxation waters will be muddy for some time.

“Remote work has caused such a myriad of issues in all the different tax types,” Eisenstein said. “You have to monitor what’s happening with your employment base and what’s happening with the states’ responses.”

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Elizabeth M. Bennett was a business reporter who moved into legal journalism when she covered the Delaware courts, a beat that inspired her to go to law school. After a few years as a practicing attorney in the Philadelphia region, she decamped to the Pacific Northwest and returned to freelance reporting and editing.