Combating revenue loss will become a top priority for states with the flow of Covid-19-related federal assistance diminishing. This puts many state governments in a quandary, particularly in high-tax jurisdictions like New York, which are in the position of needing to raise revenue while keeping a lid on high rates that squeeze taxpayers.
Consider the seemingly contrasting goals behind raising the highest income tax rates in New York in an effort to gain more funds from the wealthy, while adopting a pass-through entity tax regime to help those same individuals escape the federal income tax limitation on the state tax they are entitled to deduct on their returns.
So where does that leave us now, and what can we expect in the future?
During the heart of the pandemic, many businesses were forced by government mandate to close their offices, which also forced them to shift to a remote work model to continue doing business. As more offices reopen, employees are reluctant to go back to pre-pandemic office routines.
Because many businesses used the pandemic opportunity to broaden their recruiting to remote workers—including those who may reside a good distance away from any of their offices—it becomes difficult to force existing employees to return to the office. Moreover, a significant number of firms have enjoyed banner years during the period of time their employees have worked remotely.
In essence, the restrictions of the pandemic acted as a petri dish to test the viability of the remote working model, demonstrating its vigor over an extended period of time.
Convenience of the Employer
State tax officials have been projecting different revenue models encompassing remote workers to various degrees. Of course, their concern is the loss of revenue from companies located within their geographic boundaries that employ out-of-state workers who perform services remotely in their state of residence.
New York, Massachusetts, Arkansas, Connecticut, Delaware, Pennsylvania, and Nebraska have some form of what is commonly known as a “convenience of employer rule” in place. The basic concept is that if an employee decides for their own convenience (as opposed to that of the employer) to work remotely outside the state where their office of employment is located, all of their wages during that period are sourced to the state where their office is located. This results in that state being entitled to subject those wages to income taxes, and it prevents a loss of tax dollars due to remote workers.
For the most part, except for Massachusetts, these rules were in place before the pandemic and were based on the concept that an individual should not be able to avoid state taxes merely because they choose to work in a state other than the one in which they are employed. Should these laws apply to situations where offices are mandated to close by state governments, forcing nonresident employees to work remotely out of state? Certain states, such as New York and Massachusetts, enforce their convenience rules, notwithstanding the lack of firm footing during periods of exigency.
How can it be said that an employee is working from home for their own convenience when their office of employment is closed pursuant to governmental order? Will other states try to adopt some form of the convenience rule as remote work becomes part of the business landscape? If they do, it is likely they will look to other forms of support for such rules.
Perhaps a concept such as economic viability will come into play, such as tying the ability of individuals to work remotely to particular employers that often are in large urban areas such as New York City, Chicago and Los Angeles, where significant business opportunities exist. Under such a concept, like the hub of a wheel, these urban centers may be viewed as providing support and economic sustenance along the spokes to remote workers located along the wheel’s rim.
A further consideration is how states would respond to an expansion of convenience of employer rules with respect to their credits for taxes paid to other states. In general, states allow their residents to take a credit against their resident state income taxes for taxes paid to other jurisdictions as a result of income earned in those jurisdictions. Because most states take the position that income earned by performing services within their boundaries is subject to tax by them, what happens when employees working remotely are subject to a convenience of employer rule by the state where their employer is located? The possibility of “double taxation” may become very real.
The Realities of a Mobile Workforce
As the standard workplace model continues to shift from the traditional office to the modern mobile version, it is likely that employees will consider moving to other areas of the country based on lifestyle preferences, climate, cost of living, or environment. The shifting employment paradigm, when compounded with tax increases such as those recently enacted in New York, may increase the flow of high net worth individuals to areas of the country they view as being more economically friendly.
In part to help prevent such an exodus, states have been enacting pass-through entity tax provisions. Under PTET provisions, owners of entities such as limited-liability companies (taxed as partnerships), subchapter S corporations, and partnerships are provided a means of avoiding the $10,000 limitation on the deductibility of state taxes on their personal federal income tax returns. These state laws have proliferated since the IRS issued guidance that it would respect them.
The basic concept behind the PTET statutes is to impose a tax on the pass-through entity that may be deducted from the entity’s income as a business expense for federal income tax purposes, and then pass the state tax paid at the entity level to its shareholders or partners as a credit against their own state personal income tax liability. Accordingly, the entity’s owners are afforded a means of avoiding the federal limitation on the amount of state taxes they are entitled to deduct on their federal income tax returns.
Whether the PTET laws are enough to stop the flow of people of means leaving for more economically friendly states remains to be seen.
What Will the Future Bring?
It is likely that the traditional five-day-a-week office job has gone the way of the dodo, with various forms of hybrid combinations becoming more of the norm. How state and local governments will react to these changes depends on the ultimate effect they have on their tax revenue bases.
Perhaps a focus on building up revenue from non-tax sources such as unclaimed property will become more of a priority. In addition, new and innovative tax methodologies based on economic benefits, similar to the growth of state economic nexus rules, are likely to be explored.
One thing seems to be certain: As our workforce norms evolve, our tax laws will evolve in tandem.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Tom Corrie is a principal and co-leader of the State and Local Tax group at Friedman LLP, which will become part of Marcum LLP later this summer.
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