Submitted by David Peters, CPA, David Peters Financial Group
As COVID restrictions are starting to come to an end, many companies are making decisions around whether to continue to let employees work from home. There are logistical and practical considerations when making this decision, but the tax consequences of this decision are important as well.
During lockdown, many states had special safe harbor provisions in place that essentially allowed employees to work from home without any nexus consequences. The law would essentially say that any employees that were temporarily working in the state due to COVID restrictions were disregarded for nexus purposes. This was significant because nexus is a legal term for how much of a connection a company must have with a state before it can be taxed. In other words, if a company does not have sufficient nexus with a state, it generally has no responsibility for paying taxes there. For sales tax and income tax purposes, the physical presence of an employee in the state can create nexus. During COVID, this was not a problem for companies due to these safe harbors. However, as lockdown restrictions have gone away, so have these safe harbor rules. In many states, including South Carolina, Georgia, Alabama, Louisiana, and many others, taxpayers are going back to the pre-COVID rules for figuring out nexus.
For sales tax purposes, nexus has changed a bit since the Wayfair decision in 2018. While the physical presence of employees in a state has generally always created nexus for a company, there have been some practical exemptions given in certain states for employees who merely serve administrative functions. In a minor number of states, if an employee was not customer-facing, he/she did not establish nexus for that company. However, since Wayfair, more and more states have established economic presence standards for establishing nexus. Most often, states have matched the South Dakota model, in which 200 or more transactions or more than $100,000 in revenue in a given year will create nexus. As states become more aggressive in claiming the income of businesses, perhaps it should come as no surprise that in a recent Bloomberg survey, 33 states said that even administrative employees in their state would create nexus for a company.
Perhaps the bigger issue is in the area of income taxation, though. Historically, non-business income (like interest, dividends, and capital gains) was allocated 100% to one state. Business income was apportioned based on the Massachusetts 3-factor model. In this model, companies would examine where their sales dollars were sourced, where their property was located, and where their employees were performing services. Applying an equal weighting to each of these factors, a company would come up with a percentage of business income to be allocated to the state. Put simply, non-business income was allocated (all or nothing in a state), and business income was apportioned (percentage of income).
Nowadays, many states have adapted to an internet world and put a heavier emphasis on the sales factor – essentially conceding that it does not matter where employees or property are located for most businesses. For example, in Virginia, the sales factor is double-weighted. In Georgia and South Carolina, only the sales factor is considered. Additionally, many states have gravitated away from any distinction between business and non-business income calling any income apportionable.
For any state still using employees in their income apportionment factors, working from home could materially change their overall taxes paid. A company goes from owing no taxes in a state to owing a significant amount just simply because employees are telecommuting. Even in states that don’t have an employee factor, marketing within a particular state could create nexus as well.
As practitioners, we should remind our clients about these changing requirements. Ask them about employees who are still working from home – how many employees are now out of state? Do those employees do more than administrative tasks? Have they registered with the taxing authorities in these states? While we cannot make the final call regarding a company’s policy on remote work, we can ask them questions so that they can make more informed decisions.