Navigating the nuances of taxation in hybrid work arrangements
While the remote work arrangement has decreased since the end of the COVID-19 pandemic, employers are showing a preference for the hybrid arrangement. Rather than require a full return-to-office schedule, employers are offering employees a hybrid arrangement.
The hybrid worker by the numbers
A hybrid working arrangement permits employees to work remotely for part of the work schedule. The number of in-office days of such arrangements varies, but according to a recent study by Webex with over 14,000 employees and 3850 employers across 19 countries participating, the average hybrid arrangement is three to four days in the office per week while a Gallup poll found that US employers favor a three-day, in-office schedule.
With 75% of employers in the Americas forecasting that the average employee will be a hybrid worker within two years, employers should carefully consider the tax implications of such arrangements where the employee may be working in one state in-office and remotely in another state at home.
Challenges presented by the hybrid worker for human resources and payroll
With over 30 years of experience in state and local tax laws, Lynn A. Gandhi, partner of Foley & Lardner LLP’s Detroit office and member of the Tax, Employee Benefits & Executive Compensation, and Estate Planning Practices, noted that while the human resources (HR) department were experts at labor and benefits requirements, HR lacked the background in payroll taxes. Creating further challenges, Gandhi noted, is the fact that payroll is outsourced and that smaller payroll providers may lack the knowledge of “jurisdictional limitations on state and local tax or multi-state tax.”
Withholding tax considerations for the hybrid worker
Gandhi explained that generally, residents pay on 100% of their income in the state of residency. For individuals who work out-of-state, the individual will owe taxes for income earned in that state. However, the individual can receive a credit from the state of residency.
Gandhi noted that things get complicated in states with a “convenience of the employer” rule. She explained the term “convenience of the employer” is a misnomer. Under the rule, employees are considered to be assigned to the work location for withholding tax purposes unless the employer requires the employee to work from home. This may pose significant issues.
Convenience of the employer rule
For example, Gandhi referenced a suit, Zelinsky v. NYS Tax Appeals Tribunal, 801 NE2d 840, 11/24/2003, challenging New York’s convenience of the employer rule brought by a law professor who worked for a law school located in New York from his home in Connecticut part of the time. Professor Zelinsky asserted that he should owe New York income tax only on the amount of income attributable to days that he taught at a New York City law school.
However, the New York Court of Appeals ruled that the state’s statute neither violated the Commerce nor Due Process clauses of the US Constitution. Gandhi explained that Zelinsky was able to get a credit on his Connecticut income taxes for taxes paid to New York, however, at the time, the taxes withheld in New York were greater than his taxes owed to Connecticut, so Zelinsky challenged the law and subsequently failed.
Zelinsky is currently challenging the convenience of the employer rule again during the COVID-19 pandemic when workers had no choice but to work from home. It has already been struck down by a New York Administrative Law Judge.
Communication is key to tax compliance. Gandhi advised that employers must confirm the state of residence for their employees and how their wages will be reported. Further, employers should not offer tax advice and instead direct employees to consult their tax adviser. Finally, Gandhi warned that employers should explain that a hybrid work arrangement is not a “work from anywhere” arrangement. She strongly advises that employers should have a policy that employees report changes to a hybrid work location since such changes may have implications for the employer.
Gandhi offered the example that an employee may want to work remotely from Italy while on “vacation.” Gandhi clarified there are numerous tax implications for both the employee and the employer. For instance, the employee lacks a work permit to work in the country and the employer is not registered to operate in the country. Also, the country may have “a host of local work labor laws.”
Unemployment tax considerations for the hybrid and remote worker
Hybrid worker vs. remote worker. For an employee who works in one state in-office and another state from home, Gandhi explained that the employer would follow the rules of the state where the office is located. The employer is not considered as establishing a work location in the state where the remote work is performed.
While a hybrid worker who goes into the office part of the time has an assigned work location, things may not be as clear for the fully remote worker. Gandhi explained that if the employer acknowledges on day one they do not have an assigned work location for the employee, the remote work location becomes a new work location for the employer. The employer would then owe state unemployment taxes to this new work location. Employers would then be required to register with that state and fulfill the state’s reporting and contribution requirements.
PFMLI programs
Gandhi further explained that for those states that have paid family and medical leave insurance (PFMLI) programs, the rule for unemployment tax would apply. Contributions would be paid to the assigned work location and the employee would apply for benefits from that state.
The number one pitfall for employers
Gandhi said the number one pitfall for employers is a lack of communication within the company regarding an employee’s unique work arrangement. For instance, management may fail to inform HR or HR may fail to inform the tax department of a change in an employee’s work location. Gandhi believes this occurs when parties do not understand the impact of an employee’s work location.
She shared a case where management permitted an employee to work remotely out-of-state for six to eight months while their mother was placed in hospice. Unfortunately, management failed to inform HR and payroll. As a result, when the employee received their W-2, the employee questioned why income tax was withheld for the state of the prior work location. Gandhi further noted that just because someone lives in a state does not necessarily establish residency.
Recommended best practices for employers
Inter-departmental task force
To address communication issues, Gandhi suggested businesses form a task force made up of operational staff to better inform staff on HR reporting and payroll implications. Having a task force, Gandhi said, would educate staff as well as keep the lines of communication open. Most importantly, Gandhi stressed that employees involved in payroll tax must be kept in the loop.
Checking in with employees on work location
Employers must ask their employees where they are performing work. Further, employers should clearly communicate to employees that they must inform the employer if there is a change to their remote work location. Gandhi emphasized that employers need to know an employee’s remote work location, not only for tax purposes, but also for security reasons and labor law compliance.
Limiting time in different work locations
Gandhi noted that she has seen employers create policies that limit work locations. She stressed that, more importantly, employers should limit the time spent in a different work location. Such as limiting a change of work location to no more than two weeks. Gandhi urged employers to rethink their policies to address what may be the “greatest harm” if they fail to be notified.
Payroll tax is the next big thing in multi-state taxation
Gandhi offered this prediction: “I personally believe that payroll taxes are kind of the next horizon in the world of multi-state taxation…I remember when sales tax was the poor stepchild, and now that is a very significant tax and I think payroll taxes are going to have their time in the sun, particularly employee withholding.” With the continual rise of employers with workers in multiple state and local jurisdictions and states eyeing how to tax individuals outside of the conventional in-office work model, compliance is likely to remain challenging for employers for years to come.
Checkpoint Resources:
- Payroll Guide ¶29,105 Topic Roadmaps: Remote Workers
- Payroll Chart: Federal and State Withholding > Resident/Nonresident Taxation — Convenience of the Employer Rule
- Payroll Guide ¶5003 Resident/Non-resident withholding, Nexus Assumed
