In the second installment of Ogletree Deakins' new podcast series, Payroll Brass Tax, Mike Mahoney (shareholder, Morristown/New York) and Stephen Kenney (associate, Dallas) discuss multi-jurisdictional tax issues for hybrid and remote employees. Stephen explains the complexities employers face with varying state and local income tax withholding rules, unemployment insurance contributions, and state-specific benefit programs, emphasizing the importance of a state-by-state analysis. Mike and Stephen explore the nuances of non-resident income tax withholding, reciprocal income tax agreements, and the "convenience of the employer" rule. They also address the impact of multi-jurisdictional employees on state benefit contributions and the registration obligations for employers with remote workers in new jurisdictions.
Transcript
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Mike Mahoney: Welcome to the second installment
of Payroll Brass Tax. I'm your host, Mike
Mahoney, a shareholder out of Ogletree's Morristown, New
Jersey, and New York City offices, and joining me today is Stephen
Kenney, an associate out of our Dallas, Texas, office.
Today we've got a special topic that's probably near
and dear to many of our clients' hearts, as we're going
to be talking about multi-jurisdictional tax issues for either
hybrid or remote working employees. With that, let's get this
kicked off. Stephen, when thinking about multistate work
arrangements, what payroll tax issues do employers need to keep in
mind?
Stephen Kenney: So really here, employers have to manage the
varying state and local income tax withholding rules, so they have
to determine the where and the when. So, where do unemployment
insurance contributions need to be made? Where do income tax
withholding remittances need to be made and when do they need to be
made based on travel schedules or based on the assignments of
individual employees?
Employers also have to navigate state-specific benefit programs,
and these complexities increase when employees live and work in
different states or they travel to multiple states due to their
duties and responsibilities, and it requires employers to carefully
track the employees' whereabouts and able to be in compliance
with each jurisdiction's requirements.
Mike Mahoney: With respect to the income tax piece of that, when does an employer have an income tax withholding obligation for a non-resident working within a state?
Stephen Kenney: So, here we have the classic lawyer answer of,
well, it depends. So, generally, the location where services are
performed is the driving factor in determining whether an employer
has an income tax withholding obligation, but of course, there are
exceptions. There are certain exceptions for bilateral reciprocal
agreements between states, though those are dependent upon the work
state and the resident state.
Other states implement a convenience-of-the-employer rule to
determine non-resident income tax withholding, and really, each
state is permitted to set its own threshold as to when an employer
has a non-resident withholding obligation, which creates even more
complexity. Much of the complexity that employers face is complying
with non-resident withholding rules, but there's a lack of
uniform thresholds throughout the country. The majority of states
have no thresholds. That is, residents that work within a state are
subject to withholding in the same way that they are in a resident
state. So, that would be day one within the state, first dollar
earned within the state is subject to non-resident income tax
withholding.
Other states do have days or dollar thresholds that a non-resident
must exceed in order to trigger an employer withholding obligation,
and then certain states do not have an income tax, so there is no
employer withholding obligation regardless of the length of time
the non-resident is spending within that state or the amount of
wages earned in the jurisdiction, but yet there still may be a
withholding obligation for the resident state while that
non-resident is working in a state that doesn't have income
tax withholding. In essence, it becomes a state-by-state analysis
to apply the non-resident income tax withholding rules to wages
earned by non-residents while they're working in the
non-resident state, but then also taking into account the
withholding requirements of the resident state.
Mike Mahoney: You touched on a couple different topics there, and I'm going to come back to some of them, but I think my first question is if an employee works a hybrid schedule, one where they're working within one jurisdiction at an office location and some other period of time from a different jurisdiction from their home, what are the employer's income tax withholding obligations in that hybrid scenario?
Stephen Kenney: So, when an employee splits time between two
jurisdictions, so for example, they might have an office in one
state and their home might be in another, so they're spending
some of the time working from the office, some of their time
they're working from their home remotely, the employer is
required to withhold income tax for each one of those states based
on the wages earned in each location.
So, you have to allocate wages between those two states unless
there is some other arrangement between those two states. The
employer has to accurately track workdays and has to accurately
track the locations to ensure proper withholding and reporting. But
in certain locations in the country, you have states that
understand that employees regularly cross state lines, and in those
situations, you often end up with those states that are bordering
each other entering into a reciprocal income tax agreement with
each other.
Mike Mahoney: Talking about that for a second, reciprocal income tax agreements, can you shed some light on what those are and how they impact an employer's income tax withholding obligation?
Stephen Kenney: Yeah, so reciprocal agreements between states
allow employees to pay income tax only to their state of residence,
even if they're working in a neighboring state. Employers in
states with such agreements only have to withhold taxes for the
employee's home state, which simplifies compliance and avoids
double taxation.
These agreements are not universal, though, and must be verified by
each state payer. For instance, a classic example is Pennsylvania
and New Jersey. They both had to enter into the agreement
independently. Pennsylvania couldn't obligate New Jersey to
enter the reciprocal agreement, New Jersey couldn't obligate
Pennsylvania, but they had to enter into it independently, and now
they have a reciprocal arrangement that allows the residents of
each respective state to only be taxed by their resident state.
Mike Mahoney: Thanks, Stephen. I want to circle back to one other of the exceptions to the general state income tax withholding rule. You mentioned this phrase convenience of the employer. Can you provide some insight on how that impacts an employer's obligation to withhold income tax?
Stephen Kenney: So, under the convenience of the employer rule,
also known as simply a convenience rule, when income is paid to
non-residents for work performed outside of a certain state, it is
subject to tax in the employer's location if the employee is
working remotely for his or her convenience. So, this rule applies
in certain states and requires employers to withhold income tax for
the state where the employer is located if the employee works
remotely for their own convenience and not out of the necessity of
the employer. So, to simplify it, essentially it treats the
employee's remote work location as if it were an extension of
the employer's office, regardless of whether the employer
requires or benefits from the employee working remotely.
So, states such as New York, Pennsylvania, Delaware, and Nebraska
enforce this rule and it can potentially result in double taxation
for remote employees if not handled properly, because you could
have a remote employee that's subject to the resident income
tax withholding requirement, but they're also still subject
to that non-resident income tax withholding requirement in New
York, for example, because their home office that they're
attached to is in New York and they are working for their own
convenience from a remote location, which, in New York's
opinion, is that employee is benefiting from that relationship, the
employer is not necessarily benefiting from that arrangement, and
so the convenience of the employer rule is in play subjecting that
employee's wages to New York income taxes.
I mentioned New York, because New York's convenience of the
employer rule is the most robust. The New York State Department of
Taxation and Finance has released a number of primary, secondary
and other factors that it uses to determine if an employee's
home office is considered a bona fide employer office, and that
determination dictates whether the out-of-state remote work
arrangement is for the employer's convenience or the
employee's convenience. If it is determined that it is for
the employer's convenience, then the wages paid to the remote
employee are not subject to New York State income tax.
Mike Mahoney: I can speak from experience that New York does enforce that rule pretty strictly on its employment tax audits, but I want to pivot a little bit. We've been talking about the income tax obligations an employer has, but how do multi-jurisdictional employees impact an employer's contribution requirements for state benefit programs like unemployment insurance or state disability insurance?
Stephen Kenney: So, a multi-jurisdictional employee can complicate unemployment insurance contributions and other social taxes, because generally employers pay state unemployment tax to the state where the employee principally works, but specific rules apply when work is performed in multiple states, and that requires careful analysis of each situation.
Mike Mahoney: If an employee works in multiple jurisdictions, how does an employer determine the single jurisdiction where state benefit contributions should be made?
Stephen Kenney: Yeah, so unemployment insurance is a jointly run
federal and state program, so there is a uniform four-factor test
that applies to all the states that determines which state's
unemployment insurance law covers the multistate employees. The
four factors used in this test are: number one, localization of
service; number two, base of operations; number three, place of
direction or control; and number four, residence of the employee.
The factors are applied in a cascading manner, so if the first
factor is determinative, then there is no need to consider the
additional factors. If the second factor is determinative, then
there is no need to consider the third and fourth factors, and so
on and so forth.
So first, let me get into localization of services a little bit.
So, service is considered localized and covered in a particular
state if it is performed entirely within that state, where it is
performed both within and without the state, but the service
performed outside the state is incidental to the individual service
performed within the state. Service can be considered incidental,
for example, if it is temporary or transitory in nature or consists
of isolated transactions.
The second is base of operations. So, if an employee service is not
localized in any state, and I will say that typically localization
is determinative, but if it's not, then we go into base of
operations. How we look at base of operations is does the
individual perform some service in the state in which the base of
operations is located. The individual's base of operations
should not be confused with the place from which the services are
directed or controlled, that's factor number three, but
instead the base of operations is the place or fixed center from
which the employee starts work and to which the employee
customarily returns in order to receive instructions from the
employer or communications from customers, or to perform any other
functions necessary to exercise the employee's trade or
profession.
The base of operations may be the employee's business office,
which may be located at the employee's residence or the
contract of employment may specify a particular place at which the
employee is to receive directions and instructions. This test may
be most applicable to people in the sales professions.
The third factor that we consider is place of direction and
control. So, we consider this factor if an employee does not have a
base of operations, and localization is also not determinative. The
place from which the individual service is directed or controlled
is the place at which the basic authority exists and from general
control emanates. So, it's not necessarily are they returning
back to this place, but do they perform some services in the state
from where general control emanates. Perhaps their manager is
located in that state, and that manager is providing direction and
control or general oversight to the employee's
services.
Then, finally, factor number four is the employee's
residence. So, if coverage cannot be determined based upon the
previous factors, then it's necessary to apply the test of
residence. Residence is a factor in determining coverage only when
the employee's service is not localized in any state, and the
employee performs no service in the state in which the base of
operations or place of direction and control are located.
It's typically easy to figure out what the employee's
residence is; they provided it to the employer at the time of hire.
It's just that we can't rush to factor number four; we
have to consider the first three factors before considering the
employee's residence.
Mike Mahoney: Thanks, Stephen. One other issue that some clients encounter relates to employees working from jurisdictions where that business does not have current operations. Sometimes I jokingly say employees may have done this either by asking for permission first or asking for forgiveness later. In those situations, can you discuss an employer's registration obligations in order to be compliant with employment tax requirements?
Stephen Kenney: Yeah, I think you're right there, Mike.
Asking for forgiveness is typically how I hear this come up as
well. So, if you have an employee that works from a state where the
employer has no prior operations, the employee's presence in
that state has now created nexus, the minimum contacts between the
employer and the state taxing authorities for income tax
withholding purposes, and also the State Department of Labor
equivalent for unemployment insurance purposes. So, that means the
employer is going to need to register with the state's tax
authority and also their labor agency, and that registration
includes obtaining tax IDs and also complying with the local
employment laws to fulfill the payroll tax obligations.
There's also a requirement to register with the Secretary of
State in order to be authorized to do business in the state,
because having a remote worker within the state generally does not
fall under an exception to doing business within the state for
Secretary of State registration purposes. So, since the
employee's physical location typically drives these
registration requirements, it's crucial that employers are
aware of their remote employees' work locations and track
them accordingly.
Mike Mahoney: Thanks, Stephen. And with that, I think we're going to conclude this installment of Payroll Brass Tax. We look forward to joining you next month on another hot topic of issues that we frequently advise clients on. Until then, stay well.
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