Breaking down three remote worker scenarios.
Editor’s note: this is the first part of a two-part article.
The Covid pandemic has resulted in a much higher percentage of the workforce working remotely. But remote work is not without its challenges, and the tax rules governing how wages will be taxed can be complex.
Many employers have opted to allow at least a portion of their workforces to work remotely. But having employees working from locations in states, or even countries, other than where the employer is located, raises issues as to what obligations employers and employees may owe the jurisdiction where the remote employee is located. In this first of two articles, I will focus primarily on how remote work can impact an employee’s tax liability. In our next article, I will discuss more broadly the concept of a “taxation nexus” and whether and to what extent remote employment can expose an employer to sales taxes and other obligations imposed by the state in which the remote work is taking place.
To jump start our discussion, Carlos owns a meatpacking plant in Texas. Carlos employs three accountants, each of whom works remotely for the company. One accountant, who is a resident of Texas, is working temporarily from her home in Texas. Another accountant, who also resides in Texas, is working temporarily from a rented home in New York State. Yet a third accountant is a resident of London, England, and works from her home there.
- Remote workers who reside in state
In the first case, although the employee working remotely in Texas is not actually working at the job site, she continues to be a Texas resident and so will be managing her taxes as she has done previously, i.e., paying federal taxes, but not state taxes, as Texas does not impose a state income tax. From the standpoint of the employer, there is no change of protocol when it comes to this remote employee. As there are still federal taxes the employee is obliged to pay, the employer still must abide by federal withholding rules.
2. Remote workers who reside in the U.S. but out of state
In the second case, involving the Texas resident working temporarily in New York State, the employee will have to pay federal income taxes as before, but, in addition, will have to pay income taxes to New York State even though her company is based in Texas, Texas has no state income tax, and she is a primary resident of Texas. Whether and to what extent an employee must pay taxes to the state in which the employee is working remotely depends on state law; there is no national standard. For example, there are seven states, including New York, Massachusetts, Connecticut, Delaware, Pennsylvania, Nebraska, and Arkansas, which hold to a “convenience of employer” rule. This rule allows a state to tax employees who work out of state if the employer’s principal place of business is in that state. For example, under New York’s Convenience of Employer rule, if a person is employed by a New York company, she will be considered working in New York no matter where her remote office is located, which could be another state.
So where, as in our second case, an employee is a primary resident of one state and is working remotely in another state, the employee may be required to file a non-resident return and pay taxes to the state in which they are working remotely as well as, possibly, the state in which they principally reside. To avoid the risk of double taxation, many states have reciprocity agreements with other states allowing taxpayers to set off or credit one tax liability against another. Employees should confer with their accounting professionals about how such agreements may affect them, keeping in mind that every state has its own rules. For example, one commentator points out that certain states like New Hampshire and Tennessee will not tax the wages of non-resident employees but will tax their income generated from investments.
3. Remote workers residing outside the U.S.
In the case of the employee who is a resident of the UK, things are even more complicated. Under UK law, U.S.-based employers are not allowed to employ UK residents, working in the UK, unless the American employer can show that it is present in that country. Sometimes, establishing presence may require the American company to open a foreign subsidiary, which would employ the foreign national. Alternatives to opening a new company could entail entering into an agreement with an Employer of Record (EOR), a company in the business of employing persons for the benefit of third parties, but whether this is allowed will depend on the laws of the foreign jurisdiction in which the prospective employee resides.
Foreign nationals can also be hired as independent contractors, but this can expose U.S. employers and their employees to allegations of misclassification under local law if the foreign national is really being treated as an employee. Penalties associated with misclassifying an employee as an independent contractor can be substantial for employer and employee alike.
As a rule, the U.S. does not require foreign nationals, based abroad, who are working for a U.S. company, to pay federal Income tax; the employee, however, still must pay taxes to the jurisdiction in which they work.
By contrast, however, U.S. citizens working abroad for a U.S. company may still owe U.S. taxes on wages earned for work performed in the foreign jurisdiction, but whether and to what extent U.S. expatriates owe U.S. taxes will depend on their exceeding certain income thresholds and the applicability of tax credits and other set offs to which the employee may be entitled. Regardless of whether a U.S. citizen or resident needs to pay U.S. taxes, however, they are, generally, still required to file a federal return.
The Covid pandemic has resulted in a much higher percentage of the workforce working remotely. But remote work is not without its challenges, and the tax rules governing how wages will be taxed can be complex. For employees who plan to work remotely, it is strongly encouraged that they confer with their accounting professionals to find out whether doing so could affect their tax obligations.
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