Are there State Tax Liabilities for Employers if Employees Work from Home?

1/7/2022 - By Sam Schobben

Working from home has become more than a pandemic trend. Many workers have made remote work a condition during their job search. Companies have found it effective in a time where new hires are difficult to find. This begs the question, do states have tax jurisdiction over an entity that adds remote workers in that respective state? Public Law 86-272 provides protection from states to tax income derived from interstate commerce if activities are limited to tasks such as solicitation. This protection is waived if the entity has a physical presence such as an office or warehouse. In many cases, adding remote workers will not come with tax implications or create nexus. Still, not all is lost when an employee works from home; many states allow for an exemption so long as sales fall under a certain threshold or activities of the employee exclude sales. The rules vary from state to state, and the rules are constantly evolving as COVID-19 concerns ebb and flow across the country.

How do states define a physical presence?

Some examples that would make an employee’s residence a business location are as follows:

The employee is paid for use of space
The employee's phone number is listed in the company directory
The residence is used to store company supplies or equipment
The space is used to hold company meetings [Maryland Admin Release 2009]

It is also possible to be considered having a physical presence if you have ‘substantial virtual connections’ in a state. This most commonly relates to e-commerce companies that use targeted advertising. After the South Dakota v. Wayfair 2018 ruling, this idea that you could create nexus without having a physical presence has spread across numerous states. Prior to this ruling, many states held the position that an actual physical presence was necessary to create nexus.

Activities that do not create nexus include soliciting orders for tangible property where orders are sent out-of-state for approval or rejection and delivery of goods to customers are made from outside the state. Many states have administered COVID-19 guidance, which states that employees temporarily working in-state does not create nexus for an employer [Maryland Tax Alert 05/04/20]. Whether this will still apply if these employees become permanent is not as clear.

Differences Among Employees & Industries

If you operate a technology or software company, you may face stricter regulations regarding nexus. An employee who is actively building, selling or consulting an intangible asset such as a trademark, application or other software would likely be considered having a physical presence. There is still gray area in this space, and this has been complicated further by the COVID-19 guidance states have issued. For example, a company may have its intangible assets (software) built in a friendly corporate income tax state, while having a service team scattered across the country. It is also possible to create nexus in a state if the employee is a high-ranking officer and is making management decisions while in the state. The financial services sector has benefited from the growing work-from-home environment. Since employees are not servicing assets or establishing a physical presence, employers have been able to broaden their talent pool by hiring out of state.

Strategies to Employ

From these rules, we can conclude that there are some helpful examples for remote work that do not create nexus for employers. If you are having trouble locating sales associates or consultants, hiring out-of-state is an option to consider. However, you should be careful with the tasks you assign these remote workers. Activities such as accepting orders, installation or repairing goods would create nexus in a state. If you send one of these employees to a trade show, make sure they are only promoting goods or services. Remember, no sales can be made, and orders must be sent out of state.

Questions?

Be sure to consult our Tax team for advice on nexus and out-of-state employees to ensure you are in tax compliance.

About the Author | Sam Schobben

Sam is a senior in the Tax & Accounting Services practice of Saltmarsh, Cleaveland & Gund. He works with a wide range of industries, including construction, real estate, retail, and agriculture. Sam is passionate about helping business owners maximize profits, identify & pursue opportunities, and create exit strategies. He began his tax career in 2019, working as an auditor and tax preparer.