Remote Work Tax Implications

There’s been an increase in the percentage of remote workers since 2019, partly brought about by the COVID-19 pandemic. By 2022, remote workers comprised 4.8%-41.4% of the workforce depending on the industry, with professional, scientific and technical services taking the lead.

Remote work has also resulted in lower job turnovers, thanks to increased job satisfaction. It’s great news for employers, only there seems to be a caveat — remote work and taxes have a complicated relationship and there are a few things you’ll need to keep in mind.

This article provides a clear overview of the tax implications of remote work. Plus, you’ll get some insights on how you can navigate your taxes better.

Where Do You Pay Taxes if You Work Remotely?

Your home state is the state you’ll be taxed in if you work remotely, assuming your state charges personal income tax. Your tax residency status dictates who can charge you these taxes. This is also why a dual-state residency can lead to double taxation.

That said, some states don’t impose personal income tax. In these states, you may only need to file a federal tax return:

• Alaska
• Florida
• Nevada
• New Hampshire
• South Dakota
• Tennessee
• Texas
• Washington
• Wyoming

If your employer is located in a state different from your home state, you may be subject to double taxation, depending on the “convenience of employer” rule. In this case, you’ll file a resident and a nonresident tax return.

Keep in mind that two states are not allowed to tax the same income. This is where tax credits can come in. If you have paid taxes in your home state and need to pay taxes in your employer’s state, you can get tax credits. A tax credit is a dollar-to-dollar amount of the taxes you’ve paid.

Tax credits offset your tax obligations and sometimes are refundable. For instance, if you owe $2,000 in taxes and have a credit worth $3,000, you can get a $1,000 refund. If you owe $2,000 in taxes and have a credit worth $1,000, your obligation will be reduced to $1,000.

How Long Can You Work Remotely in Another State?

Assuming you’re not working in your home state, the length of time you can work remotely in another state can be determined by the state’s temporary presence rules. These can be dependent on your earnings or the number of days you’re working in that state.

Some states require income tax for nonresidents on the first day. And if specific states establish a threshold for the number of days, they may still exempt certain professions, such as athletes and entertainers. Other states may not tax nonresidents at all. For instance, California only taxes the income of nonresidents if they’re from California sources.

Keep in mind that states have varying residency rules, too. If you’ve stayed in a state long enough, typically 183 days, then you may be required to pay the personal income tax to the state in full.

The “Convenience of Employer” Rule

If you work remotely, you need to pay taxes to your home state, but in some instances should do so in your employer’s state as well. According to the Internal Revenue Service (IRS), “convenience of employer” refers to instances where an employer has not provided essential resources for an employee to do their job remotely, such as equipment or a physical office. This rule means that the employee must provide for themselves, which is convenient for the employer.

If you can prove that you’re working remotely for your employer’s convenience, your employer’s state may be unable to tax your income. The “convenience of employer” test will determine if the employee’s income is taxable. Each state may have its own guidelines for the “convenience of employer” test.

As of now, the following states have convenience rules:

• Connecticut
• Delaware
• Nebraska
• New York
• Pennsylvania

Massachusetts adopted this rule during the pandemic, while Arkansas has repealed the rule. Out of the five remaining states, New York is considered the most aggressive in taxing nonresidents on their personal income.

Additionally, if your employer belongs in a state with this convenience rule, they may deny you tax credits from your home state.

State Reciprocity Agreements

Some states have reciprocity agreements with others, which lets you pay income tax only in your home state. For instance, Illinois has reciprocity agreements with Iowa, Kentucky, Michigan and Wisconsin. So if you live in Illinois and work in Iowa, you only need to pay your personal income tax in Illinois.

This simplifies taxation for you and your employer, especially if you’re a hybrid worker working in two states. However, if your home or employer’s state does not have reciprocity agreements, you may need to file your personal income tax in both states.

The following states have reciprocity agreements — some more than others:

• Illinois
• Indiana
• Iowa
• Kentucky
• Maryland
• Minnesota
• Montana
• New Jersey
• North Dakota
• Ohio
• Pennsylvania
• Virginia
• West Virginia
• Wisconsin
• Washington, D.C.

Tax Implications for Employers

How do taxes work when working remotely out of state? Employers have the following tax responsibilities to their remote employees, just like with other types of employees:

Register With the Proper Tax Authorities

If you have employees working remotely in another state, you may have to register as a foreign company doing business in that state. For instance, if you have California-based employees earning above the state’s threshold, then you’re required to register.

You’ll also have to register with the state’s tax authorities. Some states will have more requirements regarding employer tax contributions.

Withhold Federal Taxes

At the federal level, employers must withhold the following:

• Federal income taxes
• Social Security taxes
• Medicare taxes
• Federal Unemployment Tax Act (FUTA) taxes 

The money withheld from the remote worker is called “withholding tax” and is taken from the employee’s gross income. The employer is responsible for paying the government on behalf of the employee.

Federal withholding tax is uniform across the U.S. As an employer, you should withhold enough payment to pay the IRS. Too much payment will result in a tax refund for your employees. However, an insufficient amount will mean your employees will have to pay more on their tax returns. 

Withhold State-Level Taxes

At the state level, employers must also withhold State Unemployment Tax Act (SUTA) taxes, depending on where your remote employee is based. These are also called state unemployment insurance taxes. Most states also have an income tax employers must withhold.

Additionally, having a remote worker can trigger a sales tax nexus. States may define a nexus differently, but it generally pertains to your business’s economic or physical presence, which isn’t limited to your office or warehouse. 

If you have a remote worker in a specific state, this can establish a nexus. If so, you should register for a sales tax permit and file sales tax returns to the responsible state.

Consider Using an Employer of Record (EOR)

An Employer of Record (EOR) is a platform or service that makes it easier for you to hire employees from other states — or internationally. This third party becomes legally responsible for your remote workers and will handle payroll, regulatory compliance and other employment administrative duties. You will still keep your managerial control.

It can be a great option for smaller businesses that don’t have sufficient resources to hire across borders.

Tax Tips for Remote Workers

If you’re a remote worker, there are a few ways to ensure you’re not paying taxes more than you need to:

• Know your employment status: Understand if you’re considered an independent contractor, also known as a 1099 contractor, or a W-2 employee. If you’re an independent contractor, you’re considered self-employed and may be entitled to certain tax deductions. An employer is also not required to withhold and pay taxes on behalf of independent contractors.
• Understand state and local laws: This will help you know how much you need to pay for your personal income tax and any other regulations unique to your location.
• Report location changes: Because laws vary from state to state, reporting your location changes to your employer can help them adjust your tax withholdings. Additionally, they may need to familiarize themselves with the state laws of where you’re moving.
• Update your addresses: Your domicile and statutory location determine your tax residency status. Your domicile location is your permanent home, while your statutory residency is a place you’ve lived for a specific amount of time. The required number of days varies depending on the state. You may avoid double taxation by keeping an accurate record of where you live.
• Identify potential deductions: If you’re a full-time employee, you may not be subject to deductions with your home office locations and equipment. But you may be able to get reimbursements from your employer. However, if you’re an independent contractor, you may benefit from tax deductions if you keep accurate records of your expenses.

IRS Rules on Remote Workers

The IRS defines a remote worker as someone who performs their duties, which a company can control, at a place other than the employer’s office. However, there’s no hard and fast rule on how a company should determine whether the remote worker is an independent contractor or an employee.

The IRS provides the following questions, which can serve as your guidelines in determining these positions:

• Behavioral: Can the company control what the worker does and how they do their job?
• Financial: Does the company control the business aspects of the job — for instance, how they get paid?
• Relationship: Do the contracts include benefits, and do you have a continuing relationship?

Companies should be careful when determining the worker’s position since companies that misclassify workers can be held liable for employment taxes.

What Are the IRS Rules for Home Office Deduction?

Home office tax deductions for remote employees are only applicable if you’re self-employed or are an independent contractor. You can maximize your tax deductions by doing the following:

• Simplified method: Measure the square footage of where you work at home and multiply the number by $5 per square foot. You can get up to $1,500 of tax deductions per year.
• Regular method: Take the percentage of your workspace to the size of your whole house. Apply this percentage to your expenses at home to determine your business expenses.

To qualify part of your home as a business expense, you cannot use your remote place of work for personal activities. Your home office must satisfy one of these criteria:

• You use the home office regularly as your place of business or as a place to meet your clients.
• You use the space regularly to store inventory or product samples.
• You use the space for rental purposes or as a daycare facility.
• Your place of work is a separate structure that’s not a part of your home.

Minimizing Tax Liability

If you’re an employer, consider the following to reduce the potential taxes you owe:

• Tax-free health benefits: Consider offering your remote employees a health reimbursement Arrangement (HRA). It’s a health plan you can use to reimburse your employees for medical expenses. These are free from payroll taxes and are also tax-free for your workers.
• Tax-free retirement plans: Tax-free retirement accounts (TFRA) can be good alternatives to 401(k) and other account types. These are qualified life insurance contracts that can provide tax-free income for retirement.
• Remote work stipends: Providing an employee allowance for work necessities like an internet connection, home office setup, phone bills and more can be helpful. These are generally taxable but may qualify as nontaxable if they are “ordinary and necessary” business expenses.

Polston Tax Can Do the Leg Work for You

Remote work is pushing the boundaries of how we can do work. But as all new things can be, it poses challenges, especially when paying taxes — for employers and employees. Learning to navigate its complexities can ensure employees don’t pay more than they should. Plus, it helps employers avoid hefty penalties due to preventable mistakes. 

Here are the key points to remember:

• You can expect to pay your personal income tax in your home state unless your employer is in a state with convenience rules.
• State reciprocity agreements can help you avoid double taxation.
• If you’re required to pay two states, tax credits can help you out.
• Employers must withhold certain taxes for employees but not independent contractors.
• There are multiple ways to reduce your tax obligations, such as through deductions or tax-free benefits.

Remember, you don’t have to shoulder all this problem alone. Tax professionals like Polston Tax can do the work for you. If you need to prepare your tax returns or if you have unpaid taxes that need to be resolved, we can help you. We have extensive knowledge of the tax code and laws and can help resolve your tax-related issues with the IRS or the state. Schedule a free consultation today!