Be Aware: Telecommuting During COVID-19 Can Trigger State Nexus

It’s no secret that the sudden shut-down of businesses across the country in response to the COVID-19 pandemic resulted in a dramatic increase in the number of employees working remotely from home. In fact, for those businesses able to do so, the implementation of telecommuting has permitted companies to continue operating throughout the pandemic almost seamlessly. A handful of prominent companies, including Twitter, Facebook, Google and Amazon have indicated that some or all of their employees will be able to continue working from home until 2021, or in some cases, permanently.

As telecommuting has continued to expand, instances where the employee may be working remotely from a state other than the one in which their normal “business location” is sited, have raised numerous questions in the area of state nexus. State nexus is the level of connections a business must have with a state in order for the state to have the right to tax the business’s activities. The required level of connections with a state that will trigger taxation vary for income taxes, franchise taxes and sales and use taxes.

Consider the following example:

John usually works from his office at his employer’s sole business site in State A, but is now telecommuting from his home in State B due to the pandemic.

• • Does John’s employer need to begin withholding state income taxes from John in State B, where the services are being performed?
  • Will John’s activities in State B create income tax or franchise tax nexus for the employer?
  • If John’s employer sells tangible personal property, will his employment-related activities in State B exceed the scope of P.L. 86-272 protections?
  • If John’s employer does not exceed State B’s small-seller safe harbor for sales and use taxes, will his presence in the state establish nexus and require the company to collect and remit sales and use taxes in this state?

As the above example illustrates, telecommuting employees can create numerous unexpected state nexus issues for their employers. With regard to withholding of state individual income taxes, the American Institute of Certified Public Accountants (AICPA) has recommended to the state CPA societies that they advocate with their state tax authorities to continue the “status quo” for withholding and individual income tax rules. This would permit an employer to continue withholding based on the employee’s normal work location without regard to the where they are telecommuting from. Doing so would alleviate onerous tracking and payroll reporting changes for employers; however as of August 24, 2020, only thirteen states had issued guidance indicating their intent to maintain the “status quo” with regard to employee income taxation and withholding.

For corporate income and franchise taxes, having an employee working in another state generally triggers the physical presence standard required to establish nexus. Similarly, for businesses previously protected from income taxation within a state by virtue of P.L. 86-272, which permits only the limited presence of employees within a state for the solicitation of sales of tangible personal property, having employees working remotely within the state may exceed these protections. That’s because many of these remote workers will likely be performing duties for their employers that go beyond the mere solicitation of sales. As a result, these companies may find themselves with nexus for income tax purposes in states in which they previously had none.

Further, once nexus for income taxes has been established within a state, the additional payroll allocable to the state because of telecommuting employees will increase the company’s overall apportionment of income to states that do not rely upon a single-sales factor to apportion income. As of September 21, 2020, eighteen states and the District of Columbia had issued guidance indicating that they will not assert nexus for income and franchise tax purposes as a result of telecommuting due to COVID-19.

For sales and use taxes, state nexus rules have been greatly changed as a result of the 2018 U.S. Supreme Court ruling in South Dakota v. Wayfair, which held that physical presence is not required to establish nexus. That being the case, suddenly having employees present in a state as they telecommute during the pandemic can have significant consequences for a business. This is particularly true given the fact that the liability arising from sales taxes (based on gross sales) is generally much larger than that arising from income taxes (based on net income). As of September 21, only seven states had issued guidance indicating that they will not assert nexus for sales and use taxes as a result of employees telecommuting due to COVID-19.

Clearly, among the many issues a company must navigate during the COVID-19 pandemic, state nexus is yet another to focus on, particularly where employees are telecommuting from locations in other states.

Contributing author: Deborah E. Finch, CPA/ABV, CVA, CDA is a tax partner at Dannible & McKee, LLP.  Deb has extensive experience providing tax and consulting services to a wide range of clients, including individuals and privately held companies.  If you have questions or need assistance in determining your nexus with one or more states, contact Deb at dfinch@dmcpas.com or (315) 472-9127.