The ability to hire remote employees based in other states triggers a slew of challenging tax questions. Image: 2020 elenabsl/Shutterstock)
The pandemic helped to usher in a new wave of remote working—and given the rise of the Omicron variant, that wave seems unlikely to crest any time soon. While the rapid ascent of home offices may have initially come as a shock to more than a few corporate cultures, the truth is that business leaders who embrace long-term remote working can yield significant cost savings and boost employee morale. But first, they need to strategize around any number of complex regulatory and compliance issues that can impact everything from business taxes to worker compensation—and often come as a not-so-pleasant surprise to employers without an in-house HR department.
Avoiding those conversations altogether may not be an option. Roughly 4 million Americans were already working from home well before COVID-19 forced businesses to close their office doors, and many more could be unwilling to return to a cubicle once the public health crisis has subsided. Making a conscious choice to lean into remote working could not only help organizations mitigate employee turnover, but also grant hiring managers access to a wider talent pool no longer constrained by geography—not to mention the savings on overhead costs like office space.
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Tax considerations
That doesn't mean it will be easy. For starters, the ability to hire remote employees based in other states triggers a slew of challenging tax questions that will likely seem familiar to law firms or companies that are either located near state borders, have experience expanding into new states, or have employees who travel to job sites in other states. The "physical presence" rule dictates that employees pay taxes to the state in which their work is performed. For instance, if a company's head office is in State A but it has a remote employee working from home in State B, it would be required to withhold unemployment and state taxes in State B, even if the business doesn't maintain a physical branch office there.
However, the situation isn't always that neat and tidy. Some bordering states have entered into reciprocal agreements with one another that allow for an employee who lives in one state but works in a neighboring state to have their withholding tax paid to the work state. In other states, remote employees may find themselves facing double taxation—meaning that they must pay income tax both in the state where they reside and the state where their employer operates.
Hybrid employees
Another common tax issue facing businesses is that of "hybrid employees" or workers who split their week between two different states: the one where their home office resides and the other where their corporate office is based. While remote workers tend to be stationary, these hybrid employees are often on the move, forcing companies to continually track their whereabouts for tax purposes.
Classification of remote employees
In an attempt to reduce payroll taxes and other labor costs, it's common for employers to want to classify remote workers as independent contractors. But a remote worker doesn't necessarily qualify as an independent contractor simply because they work out of state or have some autonomy because they work from home. Evaluating whether a worker is an independent contractor is a complicated and nuanced process—largely because the tests for determining who is an independent contractor and who is an employee vary from state to state.
A worker's daily activities are just one of many factors that a court might consider when making that determination. Other factors may include the economics of the employee-employer relationship and whether the services the worker provides are integral to the employer's business, and the amount of judgment and initiative the worker exhibits.
To be sure, while separating independent contractors from employees may be difficult, the state dividing line that can exist between remote worker and employer won't just complicate tax season. Organizations with remote employees who conduct business in other states are typically required to pay premiums for state unemployment insurance. For example, if a business' headquarters is situated in State A but an employee or employees work from home in State B, the company generally needs to register with the state unemployment office of State B. Failing to do so may bring penalties for non-compliance.
Doing business in a state other than where it was formed
In the meantime, foreign qualification—or the process of applying for authority to do business in a state other than the one in which the corporation or limited liability company (LLC) was formed—also warrants some consideration. Depending on factors such as your type of business, what your remote employee is doing, how many remote workers are in a state, and how long they will be doing that work in the foreign state, you may need to "qualify" your corporation or LLC in that state.
Once qualified, the corporation or LLC will have other compliance obligations to manage. For example, a company will have to designate a registered agent—a corporation or individual with a physical address who can receive legal documents on behalf of the business—as well as file an annual report.
Are permits needed?
Additionally, municipalities will often require that home-based workers obtain a home occupation permit. Certain states have very strict permitting and licensing requirements, especially at the local level. Businesses might encounter trouble if they are paying payroll taxes in these states but have not secured any of the requisite local-level, home occupation permits.
While obtaining home occupation permits, navigating various tax concerns or maneuvering any of the other complications imposed by a remote working configuration may be daunting at times, companies still can't afford to turn away savings on office space or the opportunity to recruit top talent, many of whom are prioritizing a more flexible work arrangement. A strong compliance plan will be critical to enterprises looking to not only stay on the right side of the law, but also maintain a competitive edge in a post-pandemic business landscape.
Troy Ayala is a Compliance Business Consultant for Wolters Kluwer CT Corporation. His responsibilities include research, delivering onsite training, and assessing CT customer workflow management for all transactions, including entity management. In addition to his tenure with CT, Troy has worked as a corporate compliance paralegal at a number of large law firms, including Kirkland & Ellis and Gallagher Evelius & Jones.
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