Remote work has become more common in recent years, and the COVID-19 pandemic has resulted in employers realizing that many jobs can be done from home. Some remote workers even work in a different state than where their employers are based. These employees may have opted to move to states with lower or no income taxes, but they — and other remote employees now working across state lines — may find themselves shouldering unexpected state income tax liabilities.
Generally, you incur state income tax liability based on where you're physically present while earning the income. So, logically, if you're living and working in a different state than where your employer is located, you'd expect to pay state income taxes only in the state where you live.
But the "convenience rule" applies in the following seven states:
Under this rule, if your job is based in the state, but you choose to live in a different state as a matter of convenience — not because your employer requires you to live there — you must pay income tax in the state where the employer is based. As a result, remote employees could end up paying state income taxes in both the state where they live and the state where their employer is based.
Say, for example, that you work for a company located in New York but decide to move to another state for personal reasons. You'll still need to pay New York state income taxes on your compensation. Plus, you might be on the hook for taxes in your state of residence on the same income.
Some states offer a credit against your tax liability there for income taxes paid to other states. But not all states do so, and the credit amounts can vary. Moreover, you might not get a full credit if the amount of taxes paid in the employer's state exceeds the amount of your liability on that compensation in your home state.
In other words, if you work for a company in a high-income tax state and live in a low-income tax state, your home state credit won't be dollar-for-dollar if the credit isn't refundable. You may have selected your new home hoping to reduce or eliminate state income taxes but wind up with no such savings because you still owe taxes in your previous state.
One way to avoid a double-taxation punch would be to persuade your employer to open a legitimate office in your state. However, that isn't an option for most remote workers. The best defense, therefore, is a good offense — that is, adjusting your withholding so you don't receive a tax bill because you haven't paid enough throughout the year.
When it comes to tax withholding, your employer is required to deduct the proper amount from every check. But it's up to you to provide it with the necessary information to determine the proper amount. Take care to notify your employer of your state of residence so the proper amounts can be withheld for the proper state(s).
The rules related to the taxation of remote workers could be poised for change in the near future. States and the federal government are reassessing laws and regulations in light of the significant increase in remote work.
Some states are getting more aggressive as they eye shrinking coffers due to employees departing their states but not their employers. These states may be looking into — or have already implemented — legislation that would allow them to collect state income taxes from nonresidents who work for in-state employers. For example, California taxes nonresidents on so-called "California-source income." And more states are considering enacting the convenience rule.
At the federal level, Senator John Thune (R-SD) and Senator Sherrod Brown (D-OH) introduced the Remote and Mobile Worker Relief Act last year. If enacted, the legislation generally would prohibit states from taxing or requiring withholding on nonresidents who are present in the state for fewer than 30 days. A similar measure was introduced in the House.
Another bill would limit the ability of states to impose the convenience rule on nonresidents for periods when they aren't physically present in the state. No action has yet been taken, but these bills demonstrate that taxation of remote workers is on Congress's radar.
The different rules in each state form a complicated web that can trip up well-intentioned taxpayers. Contact your tax advisor to help you sort out and comply with your obligations in all of the relevant tax jurisdictions.
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