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Taxpayers who worked remotely in a state other than their employer’s during the pandemic face a confusing tax season, which for many involves an unpleasant surprise: having to pay taxes on the same income twice—to the state they worked in and to their employer’s state. While taxpayers aren’t intended to be taxed twice on the same income by different states, the extraordinary conditions of 2020 have set states against each other over their right to tax employees, and in many cases, they’re refusing to relinquish revenue.
Taxpayers must pay what they owe—even if it means paying two state tax authorities—or risk fines and interest on unpaid taxes, according to Jared Walczak, vice president of vice president of state programs at the Tax Foundation. “There is no other option except to pay.”
More information about the 2020 tax season can be found here.
This thorny problem might affect taxpayers who worked remotely in another state for businesses based in New York, Connecticut, Massachusetts, Pennsylvania, Delaware, Arkansas, and Nebraska. These states have a convenience of employer law that allows them to collect taxes on employees whose employers are based inside their boundaries, even if the employees never visit their state. When someone lives and works in two states, they usually pay income taxes in the state where they work, and their home state gives them a credit for the amount they paid to their employer’s state on their home state income tax return. The issue is that taxes are due where wages are earned, so people who work remotely will have to pay taxes to the state—or states—where they worked. Assume you live in Ohio and travel to a Pittsburgh office on a regular basis. “Normally, you pay income tax to Pennsylvania on job income, and Ohio gives you a credit for taxes you paid to offset that liability,” Walczak explains. “However, it’s possible that you never drove into Pittsburgh last year. However, Pennsylvania would tax you as if you had never left, and Ohio would have no incentive to give you a credit, so you would end up paying both states.” While these laws had been in place for years prior to the pandemic, they have sparked outrage after Covid-19 limits forced obligatory office closures and remote working last March. State legislators have already attempted to address this in a variety of ways. Individuals who live in New Jersey have had the best performance thus far: Last summer, the state announced that it will continue to grant a credit to offset taxes received by New York for residents who regularly commute to New York but were forced to work remotely due to Covid-19. New Jersey has lost $1 billion in revenue as a result of this. New Jersey avoids this issue entirely with its western neighbor, Pennsylvania, because the two states have a reciprocity agreement, which exempts employees from paying taxes to their place of employment; instead, an employer merely withholds taxes on behalf of the employee’s home state. A worker only needs to file a tax return in their home state.
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New Hampshire has launched a lawsuit against Massachusetts, claiming that the state has no legal authority to tax residents who regularly commute to Massachusetts but worked from home last year. New Hampshire has received assistance from four additional states in the form of briefs. The case is expected to be heard by the United States Supreme Court, according to legal experts. According to Dustin Grizzle, a tax partner at MGO, “we’re going to see a lot of tax jurisdictions fighting over this.” “We expect a lot of people to file for a refund on their New York taxes because they didn’t work in the city for the most of last year. This is putting a lot of potential for disaster on the table.” Meanwhile, many taxpayers who aren’t subject to the convenience of employer legislation are dealing with their own set of problems as a result of remote labor. Only those who worked from home in a state that has a reciprocity agreement with their employer’s state are guaranteed to avoid new difficulties this filing season. Seventeen states have reciprocity agreements with at least one other state, usually neighboring states with regular commuter crossings. Virginia, for example, has agreements with West Virginia, Maryland, and Kentucky; Arizona, with California; and Minnesota, with Michigan and North Dakota. If there is no reciprocity agreement and a taxpayer did not modify withholdings when remote work orders were implemented, taxes will have been withheld for their employer’s state, and they will owe taxes in the state where they worked remotely. According to Walczak, the amount paid to the employer’s state should be refunded as soon as possible. According to him, a potential difficulty is that the state where they worked during the pandemic can levy fines and interest on taxes not paid by 2020. People who worked remotely from another state—for example, from a vacation home or a relative’s home—must account for time spent there, file a return, and pay prorated taxes to that state. They should be eligible for a refund from their employer’s state as well as a credit for the amount paid to the third state on their home state’s return. “The vast majority of people will not be subjected to double taxation. However, they will have to go through a filing and record-keeping exercise to get things right,” says Beth Adams, KeyBank’s top tax officer. Another issue that has arisen for taxpayers is residence, according to Dina Pyron, a partner at EY and the worldwide leader of TaxChat. The question is this: If you worked remotely for more than half of the year in a place other than your home state—at your Florida villa or in an Aspen ski lodge—what would you do?
Airbnb,
Can you, for example, claim that state to be your legal domicile? This is a common question from taxpayers whose vacation state is a no- or low-tax state, such as Florida, which does not have a state income tax. However, changing a legal domicile is more difficult than staying for more than six months, according to Pyron. While you must spend at least 183 days per year in your legal home state, you must also make other adjustments, such as changing voter registration, getting a new driver’s license, and changing doctors and other services to your new state. In terms of compliance, how would a state know you were working remotely within its borders? “While enforcement will be tough, and states will probably miss a significant portion of the obligation,” adds Walczak. “People tend to leave extensive digital paper trails, making it easier for states to figure out if you haven’t complied.” States, he adds, will focus their resources on higher-dollar tax returns, where they will get the most bang for their enforcement buck. To contact the editors at Barron’s, send an email to editors@barrons.com.
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