It’s 2024. No longer is working from home merely a fad brought on by the pandemic (unlike baking sourdough or watching Tiger King). Studies suggest that nearly 30% of employees have adopted some type of hybrid work arrangement or combination of in-office working with the flexibility to work from home.[1] Remote work is becoming increasingly popular, and by all indications is here to stay.                                                                                                             

Whether to retain employees, attract top talent, or cut costs, increasing numbers of businesses are relying on a mobile workforce. Although millions of employees have adapted to working from home, remote work presents many tax challenges for employers.  Specifically, businesses need to consider the potential state tax consequences created by their employees who are “telecommuting.”  That is, employees who are working from their homes in states where their employer does not have an office or other physical location.                                                              

Nexus

As a threshold matter, an individual or business must have nexus with a state in order to be subject to tax in that state. The term “nexus” generally refers to the nature and frequency of contacts that an out-of-state company must establish in a state before it becomes subject to that state’s tax laws and jurisdiction. Nexus is a constitutional issue rooted in both the Due Process Clause and Commerce Clause. Broadly, the U.S. Constitution requires a business to have some level of “minimum” contacts with a state before the state can impose a tax without burdening interstate commerce. The Supreme Court historically interpreted this to mean that a business must be physically present in a state in order to be subject to tax in that state. But does the existence of a telecommuting employee represent physical presence of the employer such that the employer has nexus in the employee’s home state? Spoiler alert: It usually does. In fact, the majority of states have indicated that businesses with one to six employees telecommuting from their home in the state is sufficient to give the business nexus with that state.[2] Most states have even stated that a single employee telecommuting from home and performing back-office functions is a nexus-creating activity for the out-of-state business.[3] Notably, the Multistate Tax Commission (MTC), an intergovernmental state tax agency, recently placed activities performed by a regularly telecommuting employee as unprotected by P.L. 86-272, federal legislation aimed at limiting state income taxation on out-of-state businesses.[4]                                                                                                                           

In the seminal case Telebright Corp., Inc. v. Director, Div of Taxation,[5] the New Jersey Supreme Court affirmed that one employee working from home in New Jersey on a full-time basis was sufficient to subject an out-of-state corporation to tax. The Plaintiff in that case, Telebright Corporation (“Telebright”), was headquartered in Maryland. One of the company’s software developers relocated from Maryland to New Jersey; in order to retain the employee, Telebright allowed the employee to telecommute from her home in New Jersey. The employee performed her work duties from New Jersey, was supervised by the company from her New Jersey home, and Telebright withheld New Jersey income tax from her paycheck. The Telebright Court noted that the employer “regularly and consistently” permitted the employee to telecommute full-time from New Jersey. Thus, the New Jersey Supreme Court concluded that the presence of this single employee in New Jersey created sufficient nexus to subject Telebright to New Jersey’s Corporation Business Tax. 

Ultimately, the presence of telecommuters in a state might very well require a company to file withholding, unemployment, income, and sales taxes in the telecommuter’s state. To be sure, the New Jersey Supreme Court limited the scope of its decision to full-time remote workers and did not address the situation of occasional or incidental work from home. Employees performing incidental work across state lines, such as answering a telephone call or sending an e-mail from home, is likely insufficient to establish nexus for an employer in another state. Nevertheless, Telebright is certainly a warning to employers to be cognizant of the nexus implications of having employees who are working remotely on a full-time basis in another state.

Convenience of the Employer Rules                                                                                                                                                       

Under most states’ rules, nonresident employees determine the sourcing of their compensation to a particular state based on their workdays within and without the state. The formula generally consists of a ratio: the numerator being the number of days worked in the state and the denominator being the total number of days worked everywhere. Historically, defining a workday was relatively straightforward. In determining the source of an employee’s workdays, most states used a physical presence rule. Simply, if the employee was physically present and working in a state, then that specific day would be treated as a day worked in that state, even if the employee worked from home.                       

Rather than relying on a physical presence test, certain states began to source days worked by an employee at home in a different state back to the employer’s home state (i.e., the location of its headquarters). These rules, which apply to W-2 employees, are typically referred to as “convenience rules,” and largely stem from New York’s own “convenience of the employer rule.” Housed in its tax regulations, New York’s “convenience of the employer rule” stipulates that days worked outside of New York by an employee out of convenience, as opposed to necessity, are treated as days worked by the employee in New York.[6] At its core, this rule provides that if employees work from home for their own convenience–and not because they were required to by their employers–the days worked from home are treated as days worked at their assigned work location. The application of this rule also means that the New York employer must withhold New York income tax on the telecommuting employee even when the majority of the employee’s work is conducted at a location outside of New York. 

By way of example, consider an employee who is a resident of Connecticut who works for an employer located in New York and is assigned to that employer’s Manhattan office. Under New York’s rules, the days that this employee telecommutes from Connecticut are treated as New York workdays. On the other hand, if the employer required this employee to attend a seminar in Florida or a client meeting in California, then those workdays would be sourced to those respective states. 

The application of New York’s convenience of the employer rule to a situation where an employer’s New York office was closed due to the pandemic has become a hotly contested issue.  In late 2023, the New York Division of Tax Appeals issued a determination in Matter of Zelinsky, a convenience rule case now in its second iteration.[7] Nearly 20 years ago, Edward Zelinsky, a professor at Cardozo Law School in New York, unsuccessfully tried to invalidate the convenience rule on constitutional grounds.[8] Professor Zelinsky decided to bring another case in 2020, after his employer shuttered its classrooms during the pandemic and he was forced to teach remotely from his home in Connecticut. Because Professor Zelinsky was prohibited from teaching on campus, many expected the administrative law judge (ALJ) to rule that the convenience rule should not apply to his most recent case. After all, Professor Zelinsky was not telecommuting from Connecticut to Cardozo for his own convenience. In fact, for a portion of 2020, it was a violation of New York’s Public Health Law (potentially resulting in significant fines) for an employee to occupy a “non-essential” New York business office.[9] However, the ALJ upheld the application of the convenience rule to the professor, reasoning that to allow Professor Zelinsky to treat his remote workdays in Connecticut as non–New York workdays would be violative of the policy underpinning the convenience rule. Quoting language from the Court of Appeals case Speno v. Gallman[10] the ALJ explained that the policy justification for the convenience rule is that “since a New York State resident would not be entitled to special tax benefits for work done at home, neither should a nonresident who performs services or maintains an office in New York.”  Simple translation: New York does not want nonresidents who work outside of New York to avoid paying New York personal income tax on their wages.  Professor Zelinsky is appealing this determination.

With convenience rule jurisprudence largely unsettled, it is important for employers to recognize that government-mandated office closures and shelter-in-place orders do not necessarily shield the employer from the convenience rule. Indeed, the impact of employees flooding out of offices and into neighboring states during the pandemic can trigger significant state tax issues for employers prospectively. 

Employer Withholding Considerations

The obligation of employers to withhold personal income tax on behalf of their employees poses unique challenges for employers with a remote workforce. Not only do withholding requirements vary among states; states also have differing thresholds for when employer withholding obligations are triggered. Moreover, several states require employers to withhold some amount of tax for wages paid to employees with source income in a particular state. Taken to their extreme, state withholding rules could require an employer to withhold personal income tax in every state where its employees work – even for a period as short as one day. For employers with telecommuters spread throughout the country, this can prove troublesome. An employer with a base of operations in one state can quickly have withholding obligations in several states as the company’s remote workforce increases.   

Overall, when considering withholding obligations, employers should be aware that when their employees are telecommuting from another state, they are creating income tax responsibilities for themselves and payroll tax responsibilities for their employer. To provide relief and uniformity in tax policy, some states have entered reciprocity agreements with neighboring states. Under these arrangements, typically, only the state where the taxpayer resides will be entitled to collect personal income tax. Several states have adopted reciprocity agreements, including Kentucky, Ohio, and Pennsylvania. So, for example, if an employee lives in Ohio but works in Pennsylvania, normally Pennsylvania would be able to tax the employee’s income and require the employer to withhold Pennsylvania tax. But under the reciprocity agreement, Ohio and Pennsylvania have agreed to let Ohio tax the employee, since the employee is an Ohio resident. Reciprocity agreements should be carefully reviewed before they are relied on by employers to dispense with their withholding obligation in a particular state; but where they do apply, reciprocity agreements may provide employers with relief from certain employment tax requirements. Unfortunately, states with some of the largest populations, including New York, Connecticut, and California, have no reciprocity agreements with any other state. 

The application of the convenience rule by certain states to telecommuters can pose additional withholding issues for employers—and possibly, dreaded double taxation for employees.  Only a handful of states have a convenience rule. Indeed, most states continue to tax wage compensation only to the extent that the employee performs work while physically present in the state. To illustrate, let’s take the following example:

Suppose there was an employee who was living and working in New York. When COVID hit, the employer allowed its employees to work remotely, so the employee decided to return to her native state of Colorado, but continued to work remotely for the New York employer. 

This scenario would result in a dual withholding obligation for the employer. Even though the employee relocated to Colorado, because she was telecommuting to a New York office, New York’s convenience rule would source the employee’s wages back to New York. Thus, the employer must continue withholding New York tax. Also, when the employee began working remotely from Colorado, the employer’s obligation to withhold tax in Colorado was triggered. It doesn’t get better for the employee, either; here, the employee would be subject to double tax in New York and Colorado. Due to the convenience rule, the employee would continue to owe New York State tax on her wages; but Colorado, on the other hand, does not recognize the convenience rule. Therefore, since the employee was physically working from Colorado, she would also owe Colorado income tax. 

The upshot of the convenience rule is that employers are in unchartered waters when it comes to their withholding obligations in multiple states. Likewise, employees can find themselves subject to double taxation, and resident tax credits are not always available to mitigate double tax. Because of an increasingly mobile workforce, employers might have remote employees in states where the company has never had an employee before. The lack of uniformity in tax policy between states can leave employers susceptible to additional withholding tax liabilities.         

Conclusion

Before expanding their mobile workforce or allowing employees to telecommute to their jobs, employers should have a firm grasp of the state tax implications of remote work. As states become eager to generate tax revenue and offset the impact of the pandemic, employers expanding into states as a result of telecommuting employees could find themselves the target of state tax department audits and the recipient of unintended state tax consequences.    

Mark S. Klein, Chairman Emeritus of Hodgson Russ LLP, concentrates on New York State and New York City tax matters. He also has over 40 years of experience with federal, multistate, state, and local taxation. He is chair of the State and Local Taxation Sec­tion of the ACE Accounting Society. Mark is editor of New York Tax Highlights; former editor of CCH’s Guidebook to New York Taxes; and co-author of CCH’s New York Resi­dency and Allocation Audit Handbook, CCH’s New York Sales and Use Tax Answer Book, and NYSBA’s Contesting New York Tax Assessments. He has been quoted by the Wall Street Journal, New York Times, Associated Press, Miami Herald, The Boston Globe, and CNBC, and has appeared on CNN for a live interview on changing your residency.  He was named 2023 “Lawyer of the Year” in The Best Lawyers in America.  He is admitted in New York (1983), Florida (1983), New Jersey (2019) and before the U.S. Supreme Court.  Mr. Klein can be reached at mklein@hodgsonruss.com or @MarkKleinNY.

Brandon J. Bourg is an associate at Hodgson Russ LLP’s State & Local Tax Practice. He counsels individual and business clients on all aspects of state and local tax, including planning, compliance, audit, and litigation. During law school, Brandon served as a student practitioner in the Syracuse University College of Law Transactional Law Clinic. Brandon was a member of the Travis H.D. Lewin Advocacy Honor Society Negotiation Team and an Executive Editor of the Syracuse Law Review.