Even though worldwide restrictions due to the COVID-19 pandemic have been significantly lifted, remote work remains a growing global trend. In fact, research shows that 12.7% of full-time employees work from home. It is also estimated that by 2025, 32.6 million Americans will work remotely. 

This is because remote work comes with many benefits, such as more opportunities for employers to attract top talent for their openings as well as for employees to save on costs related to commuting to their offices. Still, the new era of remote work is associated with some challenges. In these changing social and economic realities, we have much to explore. Keep reading to learn more.

What Are the Tax Implications of Remote Work?

Tax Residency

As a remote worker, or an employer with remote employees in the U.S., you should first consider the difference between domicile and tax residency. Domicile is an employee’s permanent home, while tax residency is where an employee is physically located. In most cases, the domicile and tax residency are the same. 

Another question to answer is what obliges someone to pay taxes to a state. According to the U.S. Constitution, states can only tax domiciliary businesses. There are several prerequisites for taxation, one of which is the physical presence of a business in the state through an employee working there. So if an employee working from home has a permanent home in a state other than where the company is located, this could provide a state with sufficient justification to tax the business.

A woman stands in front of the blackboard with the word “Taxes” written on it.

The Different Relationships Between States

The situation with taxes gets tricky when employers and employees need to take different relationships between states into account. Broadly speaking, U.S. states can have one of three types of relationships with each other:

  • States that have a reciprocal or reverse credit agreement
  • States that have the right to tax (and potentially withhold), yet the right to claim a credit in the resident state remains, so as to avoid double taxation
  • Employment state taxes 100% of income in the state, regardless of residency or work location, using a “convenience of the employer” test

Let’s take a closer look at reciprocal and reverse agreements. To better understand these agreements, we can first explore a standard situation with no such agreements in place. In this scenario, the primary taxing right belongs to the state where the work is conducted. Double tax is then avoided through credit claims in the resident state. 

In a reverse credit agreement, the nonresident state can only tax income within its borders if the income tax rate exceeds the resident state’s rate. If the nonresident state has a lower tax rate, double taxation could occur. 

For example, if an individual from Oregon works remotely in California, they are only required to pay taxes in California on the portion of their income that exceeds what they would owe in taxes in Oregon. On the other hand, if a resident of California temporarily works in Oregon, they wouldn’t have any tax obligation in Oregon since the tax rate on their wages in California is higher than Oregon’s tax rate.

Reciprocal agreements between states allow withholding only in a single state, which is helpful. Unfortunately, such agreements are rare.

“The convenience of the employer” doctrine allows states to impose taxes on nonresidents for income earned outside the state. This doctrine applies when two conditions are met. The first condition is that the employee contributes to the business function within the state where they are assigned to a work location. The second condition is that the nonresident’s absence from the state is due to the personal preference of the employee rather than the employer’s convenience.

Tax Obligations for Employers

Employers typically deduct state and local income taxes based on where an employee performs their work, primarily considering their physical location and sometimes taking into account their place of residence.

Regarding temporary presence, some complex laws and regulations determine how long an employee can be present in a state for work before the employer is obligated to withhold income tax. When the employer becomes liable for tax withholding, the state can collect the tax directly from the employer if they fail to withhold it from the employee’s wages.

Temporary presence rules vary and often involve factors such as the number of days spent in the state or the amount of earnings. In many states, nonresident employees are subject to income tax from the first day they travel to the state for business purposes.

Employers have specific responsibilities concerning the state taxes of their remote employees. This includes withholding state income taxes from their employees’ pay and submitting those taxes to the appropriate state tax agencies. Employers must also be familiar with the tax laws of each state where they have remote employees and ensure compliance with those laws.

Some states may require employers to register with their tax agencies if they have remote employees working within their jurisdiction. Additionally, employers may be responsible for paying state unemployment taxes and workers’ compensation insurance on behalf of their remote employees.

Tax Implications for Employees

The tax situation for remote workers may become complex due to potential taxation from multiple states. Luckily, many states offer tax credits that can offset remote employees’ tax liability. Also, deductions can help decrease taxable income. These deductions may include expenses related to remote employees’ home offices, business travels, or job-related education.

Navigating taxes in a remote work scenario may be challenging and complicated due to the many considerations that it is necessary to keep in mind, both for employees and their employers. This is where Exact Tax can help. We can make sure you follow all tax-related requirements in the new era when remote work is becoming the new normal. Contact us today!