COVID-19 Triggers State Tax Withholding Concerns

If you have employees who are working from home in a different state than your company’s state, make sure to know about varying tax withholding laws.

covid-19-triggers-state-withholding-concerns
Background on tax withholding rules — and how some states are responding

As COVID-19 continues to spur employment law changes, state tax withholding is a concern among employers. Developments on the state tax withholding side are mostly centered around employees working from home because of the pandemic.

General state tax withholding rules

As a small employer, you’re required to withhold federal taxes — namely, federal income tax, Social Security tax, and Medicare tax — from your employees’ wages. Employers in most states must also withhold state income tax and, in some cases, local income tax.

These 7 states do not require state income tax withholding:

  1. Alaska
  2. Florida
  3. Nevada
  4. South Dakota
  5. Texas
  6. Washington
  7. Wyoming

Employers must typically withhold state income tax based on the state the employee works in. If the employee lives and works in 2 different states, employers must normally withhold state income tax for the employee’s work state. However, this creates a dual tax burden for the employee, who would then owe taxes for both their work and home states — this is assuming both states impose an income tax on wages.

To relieve employees of this dual tax burden, some states have a reciprocity agreement between them, which allows employees to request exemption from tax withholding in their work state. In this case, they can ask their employer to withhold state income tax only for their home state.

How telecommuting and COVID-19 impact state tax withholding

Before the pandemic, many employees worked from their employer’s office building, and all the employer had to do was withhold state income tax for the employee’s work state. However, the pandemic has resulted in mandatory stay-at-home orders and numerous employers requiring their workforce to telecommute from home.

Problems with state income tax withholding can arise if the employee’s work-from-home location is in a different state from their normal (employer) work state.

Problems with state income tax withholding can arise if the employee’s work-from-home location is in a different state from their normal (employer) work state.

If this is currently happening at your company, you will need to:

  • Determine which state tax withholding laws to apply
  • Consider any reciprocity agreements your employees were subject to before they began working from home

Additionally, there’s the “convenience of the employer” rule — which a few states, such as New York, Connecticut, Nebraska, and Pennsylvania — have historically adopted. In these states, how a work-from-home employee’s wages should be taxed depends on whether they’re working remotely for their own convenience, or for the employer’s convenience.

How states are responding

Recognizing that COVID-19 has presented challenges in terms of state and local income tax withholding, several states have provided guidance to help employers understand their obligations.

In certain states, employers can withhold state income tax, as normal, based on the employer’s work location. Employers in these states can keep withholding state income tax according to where the employee regularly worked, prior to COVID-19. A few states, however, have said they will abide by the physical-presence rule, where the tax withholding laws for the state in which the employee is doing the work will apply.

A few states, however, have said they will abide by the physical-presence rule, where the tax withholding laws for the state in which the employee is doing the work will apply.

Some states that have issued COVID-19 tax withholding guidance:

  • New Jersey and Mississippi have said that employers can keep using the same pre-COVID withholding rules for employees who are now temporarily telecommuting because of the pandemic.
  • Maryland and Minnesota stated that employers with telecommuters might have new withholding responsibilities. Employers in these states might need to withhold state income taxes based on where the employee resides.
  • Ohio exempted (for 30 days) pandemic-related remote work from its 20-day withholding grace period for municipal income tax. Ordinarily, under Ohio law, an employee incurs an municipal income tax liability after working 20 days in a covered Ohio municipality, and their employer must withhold the income tax.
  • Pennsylvania has said that if the employee is temporarily working from home in another state because of the pandemic, then the state “would not consider that as a change to the sourcing of the employee’s compensation.” Therefore, the employee would still be subject to Pennsylvania tax withholding laws.
  • Michigan has posted an FAQs on its Treasury website, stating that it does not impose city income tax on nonresident telecommuters.

If you have employees working from home temporarily because of COVID-19, pay special attention to the tax withholding laws in your state and local jurisdiction. Consult with your state Department of Revenue or a payroll advisor for clarification or further guidance.

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