How U.S. states tax wage income may be forever changed by remote work

Key Points
  • The Covid-19 remote work shift could lead to successful legal and legislative challenges against states which have relied on out-of-state workers for income tax payments.
  • New York has been among the most aggressive states at levying income tax on non-resident commuting workers.
  • Can a virtual worker be taxed in a state where they don't live? No legislator, court, or tax expert today can answer that question.
New Hampshire governor on remote workers' income tax dispute with Massachusetts
New Hampshire governor on remote workers' income tax dispute with Massachusetts

Many employees first forced into remote work at home by the coronavirus have, by now, left behind long commutes across state borders for good — New York-New Jersey, Massachusetts-New Hampshire, New Jersey-Pennsylvania, being prime examples. But did they also shed the responsibility to pay state wage income taxes to employers based in states where they don't live?

Corporate policies centered on work-from-home, and work-from-anywhere, have evolved quickly during the coronavirus pandemic. Social media company Reddit recently said it would not only allow its workers to live anywhere, but it would pay them as if they lived in one of the highest-cost cities in the U.S. regardless of specific location.

"Internationally, we have had one pay range per country, and now the U.S. will be consistent with this approach," the company said in a blog post.

That means some high salary employees could be headed to states with no income tax, but across the nation, state and local tax policies covering worker income are not consistent. Tax treatment for non-resident workers can vary, most notably, in states like New York and Massachusetts, where the amount of revenue generated from neighboring states' residents is significant. Decades-old state income tax policy based on physical presence in a workplace may defy logic, and law, in a world where remote work become permanent and common.

A state vs. state tax revenue battle

It's a question that could end up as a state versus state constitutional challenge in the Supreme Court — New Hampshire is hoping that the Court takes on its case against Massachusetts, which has put in place a temporary measure to continue taxing the wages of workers who reside in New Hampshire. New York, meanwhile, is regarded as one of the most-aggressive states in taxing wages of workers from neighboring states, and late in October, New Jersey's legislature unveiled a bill to formally consider how remote work could require changes to New Jersey's tax policy, and fight back against attempts by New York State to continue to tax its residents.

According to information from the U.S. Census Bureau's American Community survey for 2019, New Hampshire and New Jersey are among the states which have had near 15% of their commuters traveling to a workplace in another state, typically New York (New York City), Massachusetts (Boston) and Pennsylvania (Philadelphia). A Bloomberg analysis found that as much as one-fifth of New York's income tax comes from non-resident workers, as much as $700 million a month.

It is not just the courts that face new legal questions. Difficult decisions for states in need of new revenue sources, as well as workers and companies reconsidering where to locate as a result of the coronavirus, are coming. By one estimate, a minimum 14 million workers in the U.S may be on the move in the years ahead.

Can the income of a virtual worker be taxed by a state where their employer is based but which they never set foot in?

Cars moving across the George Washington Bridge, which connects New York City and New Jersey, and has been a major part of many commuters lives for decades. Close to 15% of New Jersey commuters work in other states, according to 2019 Census Bureau data.
fotog | Getty Images

"Even beyond the pandemic, I think we will see many more remote workers, and as work changes ... that means states will need to rethink how they are raising or charging income taxes, especially for places that have been business centers," said Kim Rueben, Sol Price fellow and director of the state and local finance initiative at the Urban-Brookings Tax Policy Center.

For many workers around the country, the ways in which remote work can alter tax situation remain less than well understood. A new Harris Poll conducted for the American Institute of CPAs found that more than half of Americans who have worked remotely during the pandemic (55%) are not aware of possible tax consequences. Just under half of the working population are not aware each state has its own tax laws related to remote work, as well as the physical work location of an employer.

The New Hampshire suit filed with the U.S. Supreme Court over the summer is the most notable example of the potential tax changes that could take place on a much broader scale, as it seeks to stop Massachusetts collecting taxes from residents of New Hampshire that are now working from home. 

The Massachusetts rule is set to remain in place until Dec. 31, or 90 days after the state of emergency in Massachusetts is lifted — that means New Hampshire, which levies no state income tax on workers, could be using the lawsuit as leverage to push its neighbor away from enshrining the temporary measure on a permanent basis. But before Massachusetts implemented its rule, six other states were already taxing workers where their offices were, even if they did not work in the state, and the issues with state taxation of remote workers won't go away, especially as states hit hard by Covid-19 need to maintain sources of revenue.

Fundamentally, this isn't what income taxes are. If we lose that definition, we've lost the whole sense of income tax. Don't impose income on people who don't have income in your state.
Jared Walczak
Tax Foundation

New Hampshire Governor Chris Sununu recently told CNBC that Massachusetts' revenue issues are its own to figure out, not the burden of New Hampshire residents.

"I'm not penalizing them," Sununu, a Republican, said on CNBC's "Squawk Box."

"Our workers are working in New Hampshire, and if Massachusetts has revenue issues, what they should do is lower their taxes, get rid of regulatory burdens, and be a very attractive place for business and families to want to go to instead of leaving the inner cities in droves. So they have to drive their own solutions."

Dan Kidney, a director in Wipfli's state and local tax (SALT) practice, says there might need to be significant changes in the way that states finance themselves. "If Massachusetts is saying, 'Hey, we want to finance our state government, 15% of it based on people commuting in to our state,' they're going to need to rethink their tax regime," said Kidney.

Jared Walczak, vice president of state projects with the Center for State Tax Policy at the libertarian-leaning Tax Foundation, says the seven states which have what are called "convenience of employer" rules are the likely targets in this battle, including New York. The idea is that workers who are assigned to an office by an employer located in a particular state, for the employer's "convenience," are subject to income taxes in that state. That held up during remote work forced by Covid lockdowns, during which the argument for keeping workers on a remote basis made sense for the employer's convenience, but long-term, the idea is on shakier legal ground.

Convenience laws

"Part of the logic which the convenience rules strain are that taxpayers need a substantial nexus with the state to be taxed, need substantial contact with the state and simply because an employer is located there is not typically deemed to be enough to meet that threshold," Walczak said. "The rules are inconsistent. ... which is why they are ripe for a constitutional challenge."

Experts are hesitant to say whether the Supreme Court will take the case, or issue a ruling that goes beyond a narrow interpretation, potentially punting the issue back to states, "but it is a very important question as we move more to remote work. States like New York and Massachusetts are stretching understanding," Walczak said.

The seven states which have so-called convenience of employer rules, including the temporary Massachusetts' measure, are New York, Arkansas, Connecticut, Delaware, Nebraska and Pennsylvania. Connecticut has a rule in place that is similar, though not exactly the same, and designed to only target New York.

Many states have reciprocal agreements with neighboring states by which employees who pay income taxes to both a work state and state of residence receive a credit for the double taxation from their home state. The convenience rules, though, allow a state to continue levying those taxes even when the workers assigned to an office are no longer commuting to that office. And states of residence do not need to provide the credit anymore, either, though New Jersey has decided to credit its residents for the time being if they are taxed by New York.  

While taxpayers have challenged the New York rule in the past, because it was not a state versus state battle, it could not reach the Supreme Court. "This would be the first time these rules have been challenged in federal court," Walczak said, adding that tax experts like himself believe that tax policy is wrong but New York courts deferred to the state in the past. "If New Hampshire prevailed it would imperil all convenience rules," he said.

If the court were to rule with Massachusetts, though, there is the possibility other states looking for more revenue might think about adding convenience rules. 

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Definition of why we tax workers can change

There will be more competition across states as they try to figure out how to thrive as business and population centers in the post-pandemic era. They can become even more aggressive in tax policy related to remote workers, but the risk for states like New York, and its office hub of Manhattan, is being too aggressive in its policy amid a nationwide shift to remote work and less reliance on permanent office space by corporations.

"States with large cities with outflows are trying to hang onto revenue. Ultimately it's shortsighted and can result in business relocations," the Tax Foundation analyst said.

Other tax experts say too much emphasis is placed on taxes as a reason for business siting decisions, and there is not enough evidence that taxes are the deciding factor. Though there are tradeoffs to be considered. If a New York company's workers are going to be taxed even if they move to Florida, the employer may not get the benefit of satisfied employees, or the employees may ask for more salary, and maybe the employer won't stay in New York. 

That is a logical position, but the notion that companies choose based on the tax climate and put states at the top of the list due to taxes doesn't hold up, said Darien Shanske, a professor at the UC Davis School of Law. "I wouldn't overstate it."

Walczak says the underriding issue is the more significant one. "Fundamentally, this isn't what income taxes are. If we lose that definition, we've lost the whole sense of income tax. Don't impose income on people who don't have income in your state."

One recent proposal from Senate Republicans as part of pandemic relief was the Remote and Mobile Worker Relief Act, which in essence, sets a threshold at 30 days of physical presence of the employee in a state to trigger a payment of tax to that state and, for 2020, pushes that threshold out to 90 days.

If we are really moving to a more mobile/remote workforce, then I think states should consider taxing workers whose presence is virtual.
Darien Shanske
UC Davis School of Law

Taxes are typically paid by out-of-state commuters on the basis of having received some benefits from the work state, such as use of roads and government services. But some tax experts believe it is the definition that should change in the future, away from a focus on physical presence.

Shanske said as the world changes, tax law can evolve too. He said there is a solid constitutional question in challenges of the type New Hampshire hopes the Supreme Court will hear, but he argues there is a case to be made that states have the right to tax telecommuters.

"Not being in the office every day is a positive thing, for work/life balance, and gender, but it is not clear why New York should not have a claim," he said. "That's too strong. The main issue is that the New York statute originated in a different era. Even just a few years ago, people didn't imagine this amount of telecommuting and being totally detached from an office."

He thinks the New York approach is less flawed or unconstitutional than simply outdated. "Why use physical presence when the whole problem is being able to work virtually?"

Using physical presence at a workplace, whether through convenience of employer rules or proposals like the recent one from the Senate Republicans, is not measuring the right thing, Shanske wrote in a recent Columbia Journal or Tax Law blog post.

And a version of his legal logic already resulted in one precedent setting Supreme Court case in 2018, the "Wayfair" case, which said states can require out-of-state sellers to collect and remit sales tax on sales to in-state consumers even if the seller has no physical presence in the consumer's state.

"Physical presence is an increasingly weak proxy for when a jurisdiction is providing sufficient services to justify the imposition of a tax," he wrote.

He gave as an example a partner at a big law firm who works in New York City, but lives in New Jersey, and even if they only come into the office 29 days a year, has a network of connections that the law firm can access because of the agglomeration of expertise and capital available in New York. Only a firm with a significant New York presence, what is referred to as an agglomeration economy, can pay the lawyer millions of dollars a year. Or in other words, cities like New York, Boston and Philadelphia create markets where job opportunities and salaries are high, and that can be thought of as a "service" that justifies taxation.

The world of work, and U.S. economy, need to encourage both agglomerations of talent, and mobility.

Shanske proposes that instead of thinking of taxpayers who move physically between states, taxing authorities should think of them moving "virtually" between the states.

"If we are really moving to a more mobile/remote workforce, then I think states should consider taxing workers whose presence is virtual using some kind of apportionment approach. This is, after all, how we tax the income of interstate businesses and so it is not clear why we should not do this for workers as well," he wrote.

New Hampshire Gov. Chris Sununu on work-from-home tax dispute with Massachusetts
New Hampshire Gov. Chris Sununu on work-from-home tax dispute with Massachusetts