In today’s business landscape, more companies are opting for remote workers. While this can be a great way to save on office space and other overhead costs, there can be significant state income tax implications from having remote workers.
Set Remote Work Policies
As remote work thrives, consider creating policies around employee movement out of state. Some policy options are to:
- Limit employees to “key” states where the business already has a physical presence through an office or economic nexus due to the volume of activity in the state.
- Set policies on when and how to notify the company of cross-state moves, which could include a requirement to inform the company of the move before actually moving.
Payroll Tax Withholding
Registering for payroll tax withholding is different in every state. Your current payroll personnel or third-party payroll provider may not be aware of other state registrations required at the time of registration. This is often the case regarding sales tax, income taxes, and business licenses, which differ from state to state and could inadvertently be missed or incorrectly registered with the payroll registration.
As such, it is important to consult with a State and Local Tax professional for advice before having an employee in a new state or registering for payroll tax withholding in a new state.
Changing Residency from California
California first assumes everyone wants to live in CA and be a CA resident. As such, CA’s rules and case law on what it means to be a CA resident or a CA non-resident heavily rely on each taxpayer’s specific facts and circumstances. Unfortunately, CA has historically been aggressive in asserting CA residency when the facts or documentation are unclear.
Between the pandemic and the growth in remote working, CA is positioned to pursue the numerous CA residents who now live elsewhere. Therefore, it is expected that CA residency audits will increase significantly in the next 6-12 months and may continue to be a focus of CA audits for several years.
Key Steps to Terminating California Residency
- Make legal changes from CA to the new state for both taxpayer and spouse
- Purchase or lease a residence.
- Car and voter registration(s).
- Payroll withholding(s).
- Driver’s license(s).
- Insurance, doctors, dentists, etc.
- Cut ties with CA
- Sell CA residence.
- Terminate leases for storage units, dwellings, etc.
- Create new social connections in the new state
- Social clubs.
- Association memberships (Gym, Clubs, etc.).
It should be noted that even if CA residency is terminated, the taxpayer may still be required to file a CA non-resident return in current and future years due to having “CA sourced income” if receiving income from sales or services sourced to CA. This may include:
- Stock sales, installment sales, etc.
- Pass-through entity income.
- Gain from the sale of business assets or partnership interests.
Remote Work Impact on Business Activity Taxes
Business Activity Taxes (“BAT”) are taxes on the entity, such as income, franchise, gross receipt, net worth, and minimum taxes. Just one remote employee in a state can trigger a nexus and create a BAT filing responsibility. Even states without income taxes may have a BAT filing regardless of entity structure. For example, Texas has a franchise tax similar to a gross receipts tax with limited deductions and applies to all entity types, including disregarded entities.
Many states also require no nexus for 1-2 years before you can “exit” the state and file a final BAT return. So, if you hire an employee who works in a state for only a year or so, you might be stuck with an additional tax compliance burden for longer than the employee was employed.
Business Activity Tax Trends Across the States
States are moving away from cost-performance to market-based sales sourcing and from 3-factor apportionment to single-sales factor apportionment. These changes shift the income tax burden from in-state to out-of-state taxpayers and have been a continual theme for the states in recent years.
Additionally, states continue to enact economic nexus thresholds for income tax purposes in response to Wayfair. It continues to be a key issue for taxpayers electronically providing goods and or services (i.e., SaaS).
Gross Receipts Taxes
Gross receipts taxes have started to find favor again with state legislators as they look to replace lost income tax revenues from the economic downturn. However, gross receipt taxes are generally seen by taxpayers as unfavorable to businesses, especially businesses with small gross margins or in the start-up phase.
Many major cities also have city-level gross receipts taxes often disguised as “business licenses”. Cities like San Francisco, Los Angeles, and Portland all have city-level gross receipts taxes where the revenues collected are generally used to address local issues like homelessness and provide local health services.
As you can see, there are several things to consider regarding remote workers. If you’re thinking of hiring remote employees or already have a team of remote workers, be sure to set policies and procedures in place regarding payroll tax withholding, changing residency, and business activity and gross receipts taxes. If you need help navigating these issues, contact our team.