State Tax Ramifications of Remote Workers for Law Firms

EisnerAmper’s State and Local Tax Group recently gave a webinar titled “State Tax Ramifications of Remote Workers for Law Firms,” hosted by Carolyn Dolci and presented by Gary Bingel and William Gentilesco. Gary and Bill discussed various issues surrounding telecommuting and nexus, apportionment, sourcing of service income, and various other tax and non-tax considerations. 

Nexus Issues:

The presenters discussed both technical and practical aspects of telecommuting and nexus implications. Generally, hiring or allowing an employee to work remotely in a state creates income tax, withholding tax, sales tax and other applicable business nexus. As law firms provide services, sales tax is usually not an issue. However, sales tax may apply on the computers, printer, supplies and other equipment used by the remote workers in the state.

Toward the beginning of the COVID-19 pandemic, several states passed legislation that created safe harbors where states did not assert either corporate income tax, sales tax or withholding tax nexus for having a remote worker temporarily in the state as a result of the pandemic. Some of those provisions applied to one tax and not others. Gary stated that each state’s provisions should be reviewed to determine applicability. Other states did not change the application of their nexus rules or did not provide any guidance at all. Bill questioned whether by using the term corporate tax in the state emergency relief statutes, this excluded the application of the safe harbors to partnerships. Bill concluded that although not stated, the emergency relief provisions should apply to partnerships in the same effect as corporations; however, this is as yet unclear. Gary also reminded the listeners that although states may have these emergency provisions in place, law firms should not forget about economic nexus issues, which could create nexus for the firm.

Some states began terminating their safe harbor provisions either by statute or with the expiration of the state’s declared state of emergency legislation. Notable states that terminated their safe harbor provisions include California (expired on June 11, 2021), Connecticut (applied its nexus safe harbor only to the 2020 tax year), Maryland (expired August 15, 2021), Massachusetts’s (expired 90 days after June 15, 2021) and New Jersey (emergency relief set to expire on October 1, 2021).

The presenters also discussed the applicability of the convenience-of-the-employer rule during the COVID-19 pandemic. States that have the convenience of the employer rule include Connecticut, Delaware, Massachusetts, Nebraska, New York and Pennsylvania. The presenters discussed how the convenience-of-the-employer rule applies and some possible ways to minimize exposure. As an example, assume an employee is assigned to work in the New York office, and is working remotely from a state like New Jersey. New York has taken the position that the employer should still withhold New York wages if the employee is working remotely for any reason other than the employer’s necessity to be working from that specific location. New York’s position is that even though the employer told the employee not to come into the office, the convenience rule still applies and all wages should still be considered New York-source income.

One consideration is to assign lawyers to offices in states that do not utilize the convenience-of-the-employer rule. This approach is more viable when a law firm has had other offices established prior to the pandemic in multiple states. Gary stated that it would be difficult to make the argument that by having an employee working in a WeWork space in a state where the law firm did not previously have an office, you have reassigned that employee to that state.  Additionally, should the convenience-of-the-employer rule apply in New York if an employee did not ever physically work in New York State and has always worked remotely? The New York convenience-of-the-employer rule technically applies when the employee works both within and outside of New York. However, New York could apply the convenience-of-the-employer rule if that employee goes into New York one day for a training session, so this is risky.

Gary and Bill also discussed some of the practical considerations when addressing telecommuting. Should a law firm register and file income tax returns in each state that an attorney is working remotely? What are the chances that the state will detect a temporary remote worker? What if an employee is working in a state for a few days or months and then leaves the state? Should the employer register and then unregister in that state six months later when the employee leaves that state? How many days does a remote worker have to be in a state to require the employer to withhold individual income taxes in that state? Prior to the pandemic, the answer to that question depended on the state, as they varied in the number of days required. As part of their relief provisions, some states determined that withholding was required based on the regular place of work of the employer prior to the pandemic. States that took this position included Alabama, Georgia, Massachusetts, Mississippi, Nebraska, New Jersey, Pennsylvania, Rhode Island and South Carolina.

To combat some of the confusion regarding remote workers and withholding, Congress drafted proposed legislation known as the Mobile Workforce State Income Tax Simplification Act of 2020 to try to create a 30-day threshold for when an employer will be required to withhold on employees working remotely.   However, Bill expressed doubt that this proposed law will pass.

Finally, the speakers reminded the audience that many states have resident tax credits for resident taxpayers who pay tax on the same income in two different states, thus allowing for the avoidance of double taxation. Also, several states have reciprocity agreements. One example given was the reciprocity agreement between New Jersey and Pennsylvania, wherein compensation to New Jersey residents employed in Pennsylvania will not be subject to Pennsylvania income tax and vice versa.

Apportionment and Sourcing of Service Revenue:

Gary addressed apportionment issues associated with telecommuting, as well as the effect telecommuting has on the payroll factor. Generally, states look to the unemployment tax provisions to determine the sourcing of the payroll. There is a hierarchy of four factors that are analyzed when making this determination; if the first factor is not met, the next factor is considered and so on 1) the state where the services are localized; 2) the state where the employer’s base of operations is located; 3) the state from which the employee’s service are directed or controller; and 4) the state where the employee resides.

With telecommuting, it is possible that an employer does not have a state where the services are localized or have a base of operations. Businesses may now have a workforce that either went fully remote (where the business has given up the office space) or spread out amongst various states making it difficult to determine where the base of operation is. The next factor is where is the employee’s services are directed or controlled. The employee’s work may have originally been directed or controlled by a partner from New York City or Philadelphia, but now is being directed or controlled somewhere else. In a remote working environment, do you look to where the true seat of management is, or what state the staff attorney in a law firm is reporting to? The default rule is where the employee resides. However, this has become harder and harder to determine with the current ability of the workforce to travel and work remotely in any state.

Telecommuting has also created issues with the sourcing of service income. The two methods of sourcing service income are cost of performance and market-based sourcing. Gary focused on New York and New York City and the differences in its sourcing rules for unincorporated businesses. For unincorporated business tax purposes, New York City looks to the location where the services were performed. Some law firms have taken the position that with lawyers now working remotely outside of New York City, those receipts should not be sourced to New York City.

In New York State however, for unincorporated businesses such as a partnership, the receipts are sourced to the state where the services are consummated or negotiated. Law firms now have partners working remotely and generating business in states outside of New York. Thus, if those partners are generating business while working in New Jersey, should that income be sourced to New Jersey rather than New York?

There are also some gray areas when addressing market based sourcing rules. With clients being mobile, firms are now providing services to their clients in different states than in prior years. Gary gave the example of an accountant preparing a tax return for a high net worth individual who moves to a different state during the tax preparation process. Did the market for that customer just change?

Telecommuting has also placed difficulty on determining where a business has its commercial domicile. Items such as nonbusiness income and dividends are normally sourced to a business’s commercial domicile. Generally, a business’s commercial domicile is the state in which its headquarters are located, or where the business management activities are occurring. Gary highlighted that with law firms now having partners and officers who make decisions for the business working in multiple states, it is difficult to determine where the business’s commercial domicile is located.

Additionally, several cities such as Seattle and San Francisco have taxes based on payroll or revenues earned within the city. For example, Seattle imposes its gross receipt tax on firms or companies that have more than $7,000,000 of payroll and at least one employee with $150,000 of more of wages earned in Seattle.  San Francisco has a payroll expense tax on wages earned in the city, and a gross receipts tax on receipts sourced to the city. Law firms should become familiar with these payroll and gross receipts taxes in the various cities when they have remote workers.  

Non-Tax Considerations:

Some non-tax considerations discussed were:

1. Does a law firm reduce the salary of lawyers who move to states with lower cost of living (such as Florida or Tennessee)? Additionally, does that law firm lower the billing rates for services performed by those attorneys?
2. What privacy issues exist with law firms tracking employee locations and how will employees react?
3. How do you maintain a firm’s culture when the employees are working remotely?
4. Rules regarding remote workers should be in writing to promote transparency and uniformity with the application of those rules.
5. What are the firm’s expectations regarding set work hours and employees working in the office?
6. What if a lawyer is working in Florida and needs to go to court in New York: Who pays for the travel expenses?
7. Should you include laptops and other equipment in your capital expenditures?
8. Some states have suspended their Statutes of Limitations for refunds and assessments due to COVID-19 (for example California and New Jersey). In New Jersey, the suspension of the Statute of Limitations for statutes that would have normally expired after April 14, 2020 are now suspended until 90 days after the expiration of the emergency relief statute.