Employers need to track employees’ work locations for tax compliance purposes
Remote work has created tax compliance risks for employers. Since the COVID-19 pandemic began, 28 percent of employees have worked outside their home state or country but only one-third reported all those days to HR, a 2021 survey shows. Consequently, their employers may have failed to withhold payroll taxes appropriately without realizing it.
Unless HR monitors where employees work—some 94 percent of employees say they would accept—their companies risk hefty tax penalties in the event of an IRS or state/municipal tax audit.
The 2021 Adapt or Lose the War for Talent survey, conducted on behalf of Topia, a talent mobility software company, polled 1,250 employees—half in the U.S. and half in the U.K.—who work for international companies with at least 2,500 employees. The survey, which included 250 HR professionals, was conducted from Dec. 11, 2020, to Jan. 12, 2021.
“HR leaders recognize that remote and distributed work offers a competitive edge for attracting and retaining talent and for building diverse, highly skilled teams,” said Topia’s CEO Shawn Farshchi. “As flexible work becomes a mainstay of business culture and talent strategy, HR and finance leaders must collaborate to make it work from a compliance perspective. The potential advantages are too important to ignore.”
Compliance Blind Spots
Despite increased support among employers for allowing remote work, many HR and finance departments are unprepared from a compliance standpoint. Employees may forget to report days worked outside their home state or country, for instance, while others appear to hide their location to avoid cost-of-living adjustments to their salaries, Topia noted. Among other survey findings:
- 93 percent of HR professionals were confident they know where the majority of their employees are working, and 78 percent were confident their employees self-report when working in another state or country.
- However, only 33 percent of employees said they reported all those days, and 24 percent admitted reporting none at all, even though 61 percent were aware of the tax compliance implications.
- HR professionals were more likely to have worked in a different state or country (42 percent) but still struggled to report these workdays, suggesting that self-reporting is a challenge, even for those who know the rules.
“The mobility landscape has shifted dramatically in the past 12 months. Now, every remote employee is a mobile employee,” said Richard Tonge, global mobility services leader at professional services firm Grant Thornton. “Most critical for employers is the need to manage remote-work policies once they’ve been implemented”—for instance, by requiring employees to self-report their work locations using online platforms.
“Whether for compliance or for tax savings, it is going to be critical for companies to ensure they have the proper data to defend themselves in audits as governments everywhere have large fiscal deficits and are likely to be aggressive,” said Nishant Mittal, senior vice president of Topia. “It will be extremely difficult for companies to fight an audit if they can’t prove who is working from where and for how long.”
Tax Strategies
The term “nexus” in tax law describes a business’s tax presence in a particular state or locality. “Companies may inadvertently create nexus in jurisdictions where they have previously not deemed to have presence,” Mittal explained. “There may be registration requirements, statutory laws to be followed and various types of taxes” such as unemployment insurance (UI) that may need to be paid and state taxes that may need to be withheld.
Not everything about remote work and taxes is negative, he added. “In some cases, companies may have an opportunity to save on some taxes as employees work outside high-tax jurisdictions” and to avoid, for instance, San Francisco’s gross receipts tax or New York City’s unincorporated business tax that would otherwise be owed on business income earned in those cities.
“As employers consider integrating work-from-home policies on a more permanent basis, they must examine any compliance challenges to these arrangements,” said Frank Fiorille, vice president of risk, compliance, and data analytics at Paychex, which provides technology for HR, payroll and insurance services. While some states gave a reprieve from businesses establishing tax authority based on the employee’s home location as a result of the pandemic, he noted, “that relief was not permanent.”
Adopting New Policies
Employers should “consider whether new policies regarding where employees can work should be adopted,” along with policies to ensure that employees keep HR informed if they are working out of state or in a different municipality, even temporarily, Ted Bernert, a partner with law firm BakerHostetler, recommended during a webinar presented by the firm. His advice was as follows:
- Be prepared to explain these policies to employees and the C-suite.
- Employ mechanisms to track employees’ work locations and prepare for ongoing dispersed workforces.
During the webinar, Liz Bucko, senior director of compliance products at UKG, a workforce management software company, urged employers to “ensure employees are in the correct work and home locations [they’ve given you], down to the rooftop.”
| Remote Workers’ Unemployment Insurance
Tax withholding rules may differ from UI rules, said Dave Ebersole, an associate at BakerHostetler. Employers generally only contribute to UI taxes in one state for any one employee, typically under the Interstate Reciprocal Coverage Arrangement for multistate employees, adopted by 45 states. “Employers may elect to report and pay in one state for a particular employee, provided that an employee’s services are performed in that state and the employee takes steps to obtain approval” from the state, Ebersole explained. Generally, an employer may file an election for employee UI coverage under the laws of the state where the employee is working. The agency of the elected state approves or disapproves the election, the employer notifies each person affected of an approved election and sends the elected agency a copy of the notice. |
State Law Determines Tax Obligations
States vary significantly when it comes to requiring nonresidents to pay state income taxes on earned income, according to the personal finance website How Stuff Works, which explains that in some states workers can be a nonresident who works in-state for 2 to 60 days before becoming liable for nonresident income tax, while other states have earned income thresholds instead of waiting periods.
Georgia has a combination, in which workers must have taxes withheld if they’ve worked for more than 23 days or else made $5,000 or 5 percent or more of their total income in Georgia.
Two dozen states operates under a “first day” rule, meaning nonresident workers will owe state taxes even if their work there is temporary, while others don’t tax income at all if workers are nonresidents.
Sixteen states and the District of Columbia have reciprocity agreements with neighboring states, so that employees who commute to work in a nearby state only owe income taxes in their home state.
In some instances, “states are giving corporations a pass for employees who relocated due to the COVID-19 pandemic,” according to the How Stuff Works website. In these states, “tax authorities are not requiring corporations to establish ‘nexus’ in their state if an employee relocates there temporarily due to the pandemic.”