There are roughly 1.6 million residents from the tri-state area that commute to New York City on a daily basis, with many of those residents crossing state lines before arriving at their office. Given the global COVID-19 pandemic and the initial concentration of the virus in New York City, non-essential employers have forced hundreds of thousands of workers into makeshift offices in their basements, living rooms, and spare bedrooms. For those employees who have never telecommuted or “worked from home” on a regular basis, this has created several income tax-related issues regarding which states can tax your income.
Many different issues can arise. Workers resident in a state other than the one in which they normally work face potentially nasty headaches when filing their taxes this year. This article outlines some basic areas to consider for the 2020 tax year and the likely ongoing 2021 work from home situation
Day Counts and Allocation of Income for State Taxes
If you cross state lines for some or all of your employment, you may be familiar with keeping a day count with respect to your days in a given state. Consider a regional sales manager whose job requires she visit sales branches throughout the Mid-Atlantic region. She may spend ¼ of her working days in Pennsylvania, ¼ in New Jersey, ¼ in New York and ¼ in Connecticut. At the end of the year, her employer is required to allocate her wages and commission income received among all four states equally.
If she is a resident of one of those states (NJ for example), she will file a resident tax return for NJ declaring all of her income from all sources along with non-resident tax returns for NY, CT, and PA. The non-resident tax returns reflect ONLY the income sourced (earned) to each respective state and each state would collect the applicable income taxes. New Jersey, like many states, does not double tax income earned in another state and offers a credit for those taxes paid to the extent the tax is not greater than the commensurate NJ tax.
What Happens if you Live in New Jersey and Commute to New York City?
Now also consider a resident of the state of New Jersey who works full time in New York City with very limited work-related travel. Living in NJ and working in NYC is a very common situation. That employee may typically spend 200 workdays per year earning income in the state of New York. Due to complexities related to the COVID-19 pandemic, that employee may have worked the last nine months of 2020 from a home office in New Jersey and is likely to spend at least a portion of 2021 working remotely. How will this affect income allocation among those two states when both states attempt to tax those wages as having been earned domestically?
Further consider that this employee saw an opportunity early in the pandemic to relocate to a vacation home in Maine for a month during the summer. Did that employee establish “nexus,” or a substantial enough connection to allow Maine to tax a portion of his or her income as well?
These are some of the issues that currently have professional tax advisors scratching their heads.
Incoming Tax Guidance by State
In a traditional sense, any individual who works in a foreign state would have established nexus to that state. Nexus is typically established after exceeding a de minimis threshold of approximately two weeks, although in specific circumstances, professional athletes and performers can establish nexus by performing in as little as one day/game/performance in a state.
Without accounting for the COVID-19 pandemic, the employee mentioned above would have substantial nexus to file in New York, New Jersey, and Maine, creating a complex return and a headache. While most states have remained silent on the matter, thankfully some have issued practical guidance on the topic. New York, for example, has stuck to their “convenience of the employer” methodology, meaning that unless your employer has a bona fide reason for you to work in New Jersey, you will still be considered to have worked full time in New York. New Jersey has also provided guidance that wages will continue to be sourced to the employer’s location despite the employee potentially working from home for a significant portion of the year. Connecticut unfortunately has not provided any such guidance, leaving these decisions up to the individual tax preparer for the time being. So, using the example described above, the employee would file their 2020 return similarly to their 2019 return. However, a similar individual living in Connecticut may not be as fortunate.
As of the writing of this article, 18 states have declared that individuals working remotely in state due to shelter in place restrictions will not have substantial nexus for income tax purposes. This guidance is most likely to cover young professionals who may have fled their small city apartment to spend significant time with their family in another state. Thankfully, those individuals in states that have issued guidance will not have to complicate with multiple state filings.
Additionally, 15 states have declared that out-of-state workers who are sheltering in place will still be considered to have worked in-state for filing purposes. New Jersey, along with Pennsylvania, Maryland and others will continue to treat these wages as earned out of state.
Yet 7 other states have determined that telecommuting wages should be sourced to the employee’s home state. So if, for example, an employee lived in Vermont (a state that sources to employee residence) and worked in New Hampshire (a state that hasn’t issued guidance), the income is likely to be sourced back to Vermont.
To complicate further, what would happen if the previous Vermont employee traditionally worked in Rhode Island, a state that continues to treat these wages as earned in state? This worker essentially has two states claiming the same income without either state having an incentive to follow another state’s guidance. The short answer is that it’s complicated. While states have issued telecommuting and remote work guidelines over the past decade, coordinating interstate tax issues during the pandemic has left significant gaps in legislation that may lead to double taxation and an increase in state audits.
How to break domicile/residency with your pre-COVID state?
For workers looking to relocate to a lower state tax jurisdiction, the extrication process may also be complicated, especially in audit-aggressive states like New York. Knowing the difference between domicile and residency is critical. Domicile is your home. Residency is a concept of law. For tax purposes, you are always resident where you are domiciled, but you are not necessarily domiciled where you are resident. Establishing domicile in a new state is a “facts and circumstances” test, meaning that the more “boxes” you can check in your new state, the more likely you are to win a domicile audit. It typically isn’t as simple as buying a home in a new state and spending the majority of the year in that home. States like New York will look at lesser considered items like the location of your churches, professional organizations, doctors, vehicles and voting records to make a case that you haven’t left New York permanently and you have an intention to return some time in the future. In other words, the expression “home is where the heart is” tends to ring true. If New York, for example, can prove that your intention was never to leave the state permanently, then it is likely to win a domicile audit. We encourage those looking to sever ties with one state and establish domicile elsewhere to review this excellent resource from our website.
For employees looking to break residency with a state like New York without leaving their employer, there may be a few options available to them. If their employer has offices throughout the country and the employee is likely to telecommute indefinitely, try “relocating” your home office to a different jurisdiction. Many major professional service firms and international corporations may have back office operations in lower tax states throughout the country and by relocating to your back office, you could reduce your state income tax burden. If you are employed by a smaller company and are looking to move to a lower tax state, see whether your employer would consider changing your withholding to your new state.
Managing Multi- State Tax Liabilities During COVID
As the pandemic continues into the 2021 tax year, complications like these will be revisited and permanent policies may be enacted. As employers choose to forego traditional leases and office space, more employees may find themselves satisfying the requirements to change their nexus to their home states, creating a more substantial need to make those determinations sooner rather than later. Additionally, states looking to fund significant budget gaps may look to tax residents on their telecommuting income, creating a higher potential for double taxation.
If your typical work location has changed in the last year, you should consider opportunities to reduce your state income tax burden where available. There may be some unique opportunities when realizing investment income or other financial planning between different states. A Round Table Wealth Advisor can help you navigate the complex web of interstate taxation.