Taxpayers who worked remotely in a state other than their employer’s during the pandemic are facing a complicated tax-filing season that for many includes an unwelcome revelation: having to pay taxes on the same income twice—to the state they worked in and their employer’s state.
While taxpayers aren’t supposed to be taxed twice by states on the same income, the extreme circumstances of 2020 have pitted certain states against each other over their right to tax workers, and in many cases they’re not budging, unwilling to relinquish revenues.
With no resolution in sight and the initial May 17 tax-filing deadline looming, taxpayers are required to pay what they owe—even if it means paying two state tax authorities—or risk penalties and interest on unpaid taxes, says
Jared Walczak,
vice president of vice president of state projects at the Tax Foundation. “There isn’t any recourse but to pay.”
More reading: 2020 Tax Season
This messy issue can potentially involve taxpayers whose employers are based in New York, Connecticut, Massachusetts, Pennsylvania, Delaware, Arkansas, and Nebraska, and who worked remotely in another state. These states have what’s called a convenience of employer law, which allows them to collect taxes on workers whose employers are based within their borders, even if the workers never set foot in their state.
Normally, when someone lives and works in two different states, they pay income taxes in the state they work in and their home state provides a credit on their home state income tax return for the amount they paid to their employer’s state.
The problem is that taxes are owed where wages are earned, so folks will have to pay taxes to the state—or states—in which they worked remotely. Say you live in Ohio and normally commute to an office in Pittsburgh. “Ordinarily, you pay income tax to Pennsylvania on job income and Ohio provides a credit on taxes you paid to offset that liability, so you’re not paying on the same income in both states,” Walczak says.
“Now, however, maybe you never even drove into Pittsburgh last year. But Pennsylvania would impose tax as though you never left, but Ohio would have no reason to offer you a credit so you end up paying to both states.”
While these laws have been in effect for years before the pandemic, they’ve fueled outrage since last March when Covid-19 restrictions resulted in mandatory office closures and remote working.
State lawmakers have already been trying to address this in different ways. The best results so far are for individuals who live in New Jersey: Last summer, the state declared that for residents who normally commute to New York but had to work remotely due to Covid-19, it would continue to allow a credit to offset taxes collected by New York. This has cost New Jersey some $1 billion in revenue.
New Jersey avoids this problem altogether with its western neighbor, Pennsylvania, because the states have what’s called a reciprocity agreement, which exempts the employee from having to pay taxes to their work state; an employer simply withholds taxes on behalf of the state where the employee lives. An employee only has to file a tax return to their home state.
New Hampshire has filed a legal challenge to Massachusetts, arguing that Massachusetts has no right to tax its residents who normally commute to Massachusetts but worked from home last year. Four other states have filed briefs supporting New Hampshire. Legal experts expect the case to be heard by the U.S. Supreme Court.
“We’re going to see a lot of tax jurisdictions fighting over this,” says Dustin Grizzle, a tax partner at MGO. “We’re expecting to see a lot of people filing for a refund on their New York taxes because they didn’t physically work in New York for most of last year. This is opening up a pretty big possibility for a mess.”
Meanwhile, many taxpayers who aren’t dealing with a convenience of employer law have their own set of issues to deal with due to remote work.
The only folks sure to avoid new complexities this filing season are those who worked from home in a state that has a reciprocity agreement with their employer’s state.
Seventeen states have reciprocity agreements with at least one other state, typically neighboring states whose borders are frequently crossed by commuters. For example, Virginia has a pact with West Virginia, Maryland and Kentucky; Arizona has an agreement with California; and Minnesota has one with Michigan and North Dakota.
If there is no reciprocity agreement, and a taxpayer did not adjust withholdings when remote work orders went into effect, they will have had taxes withheld for their employer’s state and will owe taxes in the state they worked remotely. But a refund should be promptly processed for the amount paid to the employer’s state, Walczak says.
A potential complication is that the state they worked in during the pandemic can charge penalties and interest on taxes that weren’t paid through 2020, he says.
As for folks who worked remotely from yet another state—say, from a vacation home or a relative’s home—they must account for time spent there, file a return to that state, and pay taxes to that state on a prorated basis. They should qualify for a refund from their employer’s state and a credit on their home state’s return for the amount paid to the third state.
“The vast majority of people won’t be double taxed. But they face an exercise in filing and record keeping to get things right,” says Beth Adams, chief tax officer at KeyBank.
Another issue that has been coming up for taxpayers is residency, says Dina Pyron, a partner and global leader of TaxChat at EY. In particular, the question: If you worked remotely for more than half the year in a state other than your home state—in your Florida condo or in an Aspen
Airbnb,
say—can you declare that state your legal domicile?
This question comes up mainly from taxpayers whose vacation state is a no- or low-tax state like Florida, which has no state income tax.
But changing a legal domicile is more complicated than being there for more than half a year, Pyron says. While you must live in your legal home state for at least 183 days a year, you must also make other changes, such as switch voter registration, get a new driver’s license and change doctors and other services to your new state.
As for compliance, how will a state catch wind that you were working remotely within its borders? “While enforcement will be difficult and states will undoubtedly miss a fair amount, the obligation exists,” Walczak says. “People usually leave long digital paper trails, making it easier for states to eventually catch wind that you haven’t complied.”
He adds that states, hungry for revenues, will use resources to home in bigger-dollar tax returns, where they get the biggest bang for their enforcement buck.
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