Remote work and taxes: It's complicated

While some might say there was an existing trend toward remote work before the pandemic began, it has certainly received a boost in the past 18 months. The pandemic accelerated digitization for many businesses while providing employees with the flexibility to work from home.

Clearly, remote work is here to stay, whether it becomes part of a hybrid plan or an indefinite policy. However, besides concerns about employee productivity, social connections and collaboration, one potential implication that many companies may have overlooked is tax obligations.

The only sure thing: Taxes

In this past year, tax laws became a major challenge affecting business leaders and their accountants and payroll teams. Many complicated tax issues were created by allowing employees to work remotely, in some cases in a state different from that of the employer. Ultimately, Uncle Sam can’t tell the difference between where an employee lives and where they earn their wages, meaning that an employer in Georgia can be responsible for out-of-pocket expenses for the employer contribution to the Massachusetts Paid Family Medical Leave Act (PFMLA). Companies with a single physical location may find themselves having a taxable presence in four or five different states, all because of the necessity of remote hiring.

Considering this, two questions have become key:

• Do employees working from home create a new tax area (also known as a “nexus”) for the employer in that state?
• Which states are owed income tax when employees work from an out-of-state location different from that of the company that employs them?

Adding to the quandary are diverse and contradictory tax rules that often vary from state to state. Sometimes, it could mean double taxes for companies – a fact that may drive employers to be more discerning when sourcing employees based on tax or other employment laws that are too risky to take on when hiring remotely.

In the face of these tax laws, what course of action should a business take?

Know the applicable laws

When employees began working from home, most states issued guidelines that dealt with in-state and out-of-state remote workers and the related tax obligations of employers. For example, approximately one-third of the states offered temporary suspension of corporate income taxes which provided some relief. However, these policies were meant to be for short-term, extraordinary circumstances and many of them are ending soon. The end of this grace period means companies will return to the original, long-standing tax laws.

Income tax implications

As remote work continues to grow, both companies and remote workers may face unexpected income tax obligations. Though these taxes do tend to affect employers more, if a remote worker moved and did not report it, it could cause tax problems for both the employee and the employer in the form of fees and audits, making it critical for businesses and employers to keep good records, maintain communications, and be transparent about any changes in work location.

Further, remote employees could be surprised to learn they have additional income tax obligations if there is not a reciprocal agreement between the state where they live and work and the state where their employer is located. In most cases, though, employees will pay income taxes in the state where they live, while employers may have to pay taxes in both states.

Going forward

Given this unique and complex relationship, companies might find out they have a taxable presence in all of the states where their remote workers are located, in addition to the state in which the company is headquartered. This is not only something employers will need to keep in mind for tax-paying purposes but also because of potential cost implications of hiring remote workers. This issue may also be a driving force for employers to encourage workers back to the office.

This could mean that businesses become more discerning when considering remote work employees. Companies will want to keep the total cost of hiring a remote employee in mind because of potential tax implications. In addition, employers may discover they are required to disclose expected salaries for job openings and that candidates expect wages that meet their cost of living in a different city. For example, a potential employee living in Manhattan may require a salary that matches the cost of living in NYC versus the cost of living for a business located in Florida. The possibility of increased costs like these – along with taxes – to take on a remote candidate may push business owners to weigh how well a job seeker meets their needs.

Since remote work does not appear to be going away, it remains to be seen whether local or federal tax laws will evolve to coincide with work practices or employee recruitment. Businesses will need to know not only where an employee resides, but also where that employee travels and how much time they spend in each location. Companies may need to take a hard look at their contract and 1099 employees to be sure they are adhering to the rules. These rules vary by state, meaning a business may face liability if a remote employee decides to move.

In the past, laws, taxes, and businesses practices have changed and adapted to accommodate businesses. Based on the experiences of the last 18 months, the answer may come with legislators drafting new tax laws so businesses, employees, and the economy thrive amid any new challenges. Until that time, employers should be mindful of potential tax issues as they conduct business. Evelyn McMullen is a research manager at Nucleus Research, a global provider of investigative, case-based technology research and advisory services. The company’s ROI-focused research approach provides unique insights into the actual results technology solutions deliver, allowing users to cut through the marketing hype to understand real operational value.