As of October 1, 2021, the New Jersey Division of Taxation ended its taxpayer-friendly policies for businesses impacted by employees working remotely as a result of COVID-19.  In this article, we discuss both the regular and temporary rules in New Jersey for the three areas of taxation impacted by the Division’s COVID teleworking policy: (1) Corporation Business Tax (“CBT”); (2) sales and use tax; and (3) employer withholding.

CBT Nexus in General                                            

A state may not subject a business to an income or franchise tax, such as the CBT, in the absence of “nexus.”  Nexus is a fundamental requirement founded in both the Due Process and Commerce Clauses of the U.S. Constitution. Nexus requires “[s]ome definite link, some minimum connection between a state and the person, property, or transaction it seeks to tax.”  Allied-Signal, Inc. v. Dir., Div. of Taxation, 504 U.S. 768, 777, 112 S. Ct. 2251 (1992).

In addition to constitutional limits on its taxing authority, New Jersey’s CBT has statutory limits.  The CBT is imposed on a corporation for the privilege of having or exercising its corporate franchise in New Jersey, or for the privilege of deriving receipts from sources within New Jersey, or for the privilege of engaging in contacts within New Jersey, or for the privilege of doing business, employing or owning capital or property, or maintaining an office, in New Jersey.  N.J. Stat. Ann. § 54:10A-2. The statute further provides that a corporation is subject to CBT “if the taxpayer’s business activity in this State is sufficient to give this State jurisdiction to impose the tax under the Constitution and statutes of the United States.” Id. Thus, New Jersey has sought to align its test for statutory nexus with constitutional nexus.                                                    

Although taxpayers have historically taken the position that nexus is not established in the absence of physical presence in a state, New Jersey courts have upheld nexus determinations against companies that have no physical presence (no property or payroll) in New Jersey.  In Lanco v. Dir. Div. of Taxation, 188 N.J. 380 (2006), the Supreme Court of New Jersey upheld CBT taxation of an out-of-state intangible holding company that earned New Jersey-source royalty income from the use of its intellectual property by its affiliate in New Jersey.  More recently, in Preserve II, Inc. v. Dir., Div. of Taxation, 30 N.J. Tax 133, 162 (Tax 2017), aff’d, 32 N.J. Tax 201 (App. Div. 2020), the New Jersey Tax Court held that an out-of-state corporation that was a limited partner in a New Jersey partnership was “subject to the CBT simply by virtue of having unquestionably derived income from New Jersey sources.”                                                  

The Division has also aggressively audited companies with limited contacts with New Jersey, finding that one employee working from home in New Jersey subjects the employer to CBT, even if the employer has no other presence in New Jersey.  In Telebright Corporation Inc. v. Dir., Div. of Taxation. 25 N.J. Tax 333 (Tax 2010), aff’d, 424 N.J. Super. 384 (App. Div. 2012), Telebright, a Maryland business, did not have an office in New Jersey or solicit sales in the state. Telebright hired a new employee to develop and write software code.  Initially, the employee was a resident of Maryland, but the employee moved to New Jersey and received permission to work remotely from her home and was provided a laptop. The employee worked 40 hours a week from her home in New Jersey. The employee did not solicit customers or have any sales responsibilities.

After audit and assessment, Telebright challenged the Division’s determination that one employee working remotely from home in New Jersey created nexus for CBT purposes. The New Jersey Tax Court found that although Telebright had never maintained an office in New Jersey, nor solicited business in the state, its daily contact with the state through its one employee working at home in the state was sufficient to trigger application of the CBT.  The court stated, “It is commonly understood that a corporation is ‘doing business’ at the place where its employees are expected to report for work, where they are regularly receiving and carrying out their assignments, where those employees are supervised, where they begin and end their work day, and where they deliver to their employer and customers a finished work product.  In this case, all of these functions are performed by [the employee] in New Jersey.” Id. at 346. The court found that it was irrelevant that the employee worked from home and that she was the only employee working in New Jersey. The court also noted that since the employee was initially given a company laptop, Telebright was technically employing property in the New Jersey.                                                                        

The Appellate Division agreed with the Tax Court and rejected Telebright’s constitutional claims, finding that Telebright had sufficient minimum connection with New Jersey to permit taxation consistent with both the Due Process and Commerce Clauses. Telebright Corp. v. Dir., Div. of Taxation, 424 N.J. Super. 384 (App. Div. 2012).

Telebright did not address the situation of occasional work from home, which certainly happened before the pandemic and will likely be more prevalent in the future. To date, there has been no New Jersey court decision that has addressed the CBT nexus implications of an employee working from home on an occasional or infrequent basis.

CBT Nexus During and After COVID-19

As a result of the COVID-19 pandemic, in March 2020 the Division announced that it would temporarily relax its CBT nexus standards:

• The Division temporarily waived the CBT nexus standard that is generally met if an out-of-state corporation has an employee working in New Jersey.
• As long as the out-of-state corporation did not otherwise meet any of the factors giving rise to nexus, other than employees working from home in New Jersey solely due to the pandemic, the Division did not consider the out-of-state corporation to have nexus for CBT purposes during the waiver time period.

This waiver of CBT nexus no longer applies on and after October 1, 2021. On and after October 1, 2021, an employee working from home in New Jersey will create CBT nexus for the corporate employer.

For businesses that were relying on the temporary CBT nexus policy, it is important to keep in mind that the Division did not provide a blanket waiver of nexus. The Division only agreed to “look the other way” with respect to an employee working from home, as in the situation described in Telebright.  If an out-of-state business otherwise had economic presence nexus or was conducting any activities with respect to New Jersey that were sufficient to satisfy the statutory and constitutional standards of nexus discussed above, then the business would not be able to rely on the temporary policy for teleworking employees.

Businesses that rely on Public Law 86-272 should be particularly vigilant about monitoring the location of their employees in a teleworking environment. Public Law 86-272 is a federal law that prohibits states from imposing a net income tax on a business engaged in interstate commerce if the business’s sole connection to the taxing state is the in-state solicitation of orders for tangible personal property, where all orders are accepted, filled, and shipped from a point outside the taxing state. Thus, even though the presence of salespeople creates nexus in a state, Public Law 86-272 prohibits the state from imposing a tax on net income if all of the requirements of Public Law 86-272 are satisfied.

As a result of the shifting landscape to a remote work environment, businesses relying on Public Law 86-272 may be surprised to learn that employees in non-sales functions have relocated to states where the businesses used to enjoy Public Law 86-272 protection. Like many states, New Jersey is not a fan of Public Law 86-272 and the Division will be quick to make the argument that its requirements are not satisfied if a non-salesperson is found to be working remotely in New Jersey.               

If a business reaches the conclusion that it has CBT nexus in New Jersey for the first time as a result of a teleworking employee, New Jersey rules on short period returns should alleviate some of the burden in the first year. Short period returns are permitted when an out-of-state company acquires a taxable status in New Jersey after the beginning of its federal accounting period. N.J. Admin. Code 18:7-12.1. The rules permit proration of both entire net income and the allocation factor. N.J. Admin. Code 18:7-12.2 – 12.3.           

Sales Tax Nexus During and After COVID                                      

Similar to CBT nexus, as a result of COVID, the Division temporarily waived the sales tax nexus standard that is generally met if an out-of-state seller has an employee working in New Jersey. Provided the out-of-state seller did not maintain any physical presence, other than employees working from home in New Jersey solely due to the pandemic (and was below the economic activity thresholds described below), the Division did not consider the seller to have nexus for sales tax purposes during the waiver time period that ended on September 30, 2021.        

Of course, if the seller had physical presence nexus pre-pandemic, the Division did not pause the seller’s sales tax nexus obligations during the pandemic. Physical presence could be established by maintaining a place of business in the state, such as an office or warehouse; having employees, independent contractors, agents, or other representatives in the state; or storing inventory in the state.    

In addition, New Jersey enacted sales tax economic activity thresholds after the U.S. Supreme Court’s decision in South Dakota v. Wayfair, 504 U. S. 298 (2018).  Under New Jersey’s rule, after November 1, 2018, a remote seller that makes a taxable retail sale into the state must collect and remit New Jersey sales tax if it either: (1) has gross revenue from sales of tangible personal property, specified digital products, or taxable services delivered into New Jersey during the current or prior calendar year, in excess of $100,000; or (2) sold tangible personal property, specified digital products, or taxable services delivered into New Jersey in 200 or more separate transactions during the current or prior calendar year.  N.J. Stat. Ann. 54:32B-3.5.  Since New Jersey’s economic nexus standard was likely to capture most larger out-of-state sellers, the temporary waiver of nexus was probably only helpful for smaller sellers with teleworking employees who were not already physically present in the state.

Now that the Division’s temporary policy is no longer in effect, an employee working from home in New Jersey will create physical presence and sales tax nexus for an out-of-state seller because working at a location in New Jersey is considered physical presence in the state. The Telebright decision discussed above supports New Jersey’s position here. However, there is an open question whether an employee working from home on an infrequent or irregular basis would create sales tax nexus. If employers move to a hybrid model of allowing employees to work a few days at home, they need to consider whether this occasional presence will create sales tax nexus.    

New Jersey Employer Withholding Before and After COVID-19 

New Jersey’s employer withholding rules were confusing before COVID-19 caused everyone to take a fresh look at the impact of teleworking employees. That is because New Jersey borders New York and is the home state for a good number of New York based employees.  Under New York’s “convenience of the employer rule,” New York ignores the working from home days of New Jersey residents and treats remote workers as if they were in their New York office.  New Jersey has generally dealt with the situation by granting offsetting tax credits (“resident credits”) to its residents in order to ensure that residents are not subject to double taxation by New York and New Jersey. 

The Division has published its policies on employer withholding in informal guidance that is updated periodically. See NJ-WT (Jan. 2021). As a general rule, an employer of a New Jersey resident who works in New Jersey must withhold New Jersey taxes on all wages. If the resident employee works both inside and outside of New Jersey, the employer must withhold New Jersey taxes in addition to the other state’s taxes to offset any New Jersey income tax liability that would exist after the application of the resident credit.    

No withholding is required with respect to a New Jersey resident if:

• The employee is employed totally outside New Jersey;
• The employee is subject to the withholding tax of the other state; and
• The withholdings required by the other state equal or exceed the withholdings required for New Jersey.

As to nonresident employees who work inside and outside of New Jersey, the Division only requires withholding on the compensation paid for work performed in the state.     

As a result of COVID-19, the Division temporarily instructed employers that wage income would continue to be sourced as determined by the employer in accordance with the employer’s jurisdiction.  For example, if a New Jersey resident employee worked in a New York office prior to the pandemic, then the employer would continue to follow New York’s rules for wage sourcing even after the employee was required to work from home in New Jersey.

The temporary relief period with regard to employer withholding for teleworking employees ended on September 31, 2021. Beginning on October 1, 2021, employers are instructed to resume sourcing income based on where the service or employment is performed and withhold New Jersey tax from such wages.

Although much of the discussion surrounding wage withholding and remote work in New Jersey has centered around New York, employers should be aware that Pennsylvania and New Jersey have entered into a reciprocal income tax agreement that pre-dates COVID-19. Compensation paid to Pennsylvania residents employed in New Jersey is not subject to New Jersey income tax under the terms of the agreement between the states. Likewise, New Jersey residents are not subject to Pennsylvania income tax for work performed in Pennsylvania.       

If you would like more information about the above New Jersey tax issues, contact Open Weaver Banks (646.218.7524) or Emma M. Savino (716.848.1559).

Open Weaver Banks is a partner in the state and local tax practice in Hackensack, New Jersey.  Her extensive experience includes representation of taxpayers in administrative and court appeals in New Jersey, New York and other states on a variety of complex SALT issues, including apportionment of income, combined reporting, constitutional nexus, the Internet Tax Freedom Act, nonresident and resident personal income taxation, sales and use taxation, and the imposition of various industry specific taxes, including telecommunications, utilities, and amusement taxes.

Emma Savino is an associate in the state and local tax practice. She handles disputes involving the New York State and City Tax Departments and counsels businesses and individuals in a range of multistate, state and local tax issues. She advises clients on all aspects of state and local tax from planning and compliance, to audit and litigation.  Prior to joining Hodgson Russ, Emma served as a volunteer law clerk for United States District Judge William Skretny of the Western District of New York. She was also employed as a law clerk at a local firm for nearly two years. Prior to attending law school, Emma worked for TJX Canada as an allocation analyst.