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Editorial 9 MIN READ

Remote work, nexus, and the payroll apportionment mess

COVID scattered the workforce across state lines and left a tax regime that was never written for it

The Editors
Staff, Incorporator.org
9 min read Updated
Contents 5 sections
  1. What the states have actually said
  2. Why UDITPA doesn't answer the question
  3. The federal piece, such as it is
  4. What to do between now and whenever this settles
  5. Sources

remote employee in Portsmouth, New Hampshire, doing the same job she did in Boston last February is now, according to Massachusetts, still earning Massachusetts-source wages. New Hampshire disagrees, loudly, and has asked the Supreme Court to say so. The payroll tax code was written for a country where people commuted, and in October 2020 that country no longer exists.

This is the remote-work nexus problem as it stands this fall: a set of rules drafted in the 1950s and 1960s, a pandemic that severed the tie between employer location and employee location, and a patchwork of state responses that range from silent to aggressive. The money at stake is not small, and neither is the administrative burden on anyone running payroll across more than one state.

What the states have actually said

Massachusetts moved first and hardest. The Department of Revenue issued Technical Information Release 20-5 on July 21, 2020, and adopted a corresponding emergency regulation at 830 CMR 62.5A.3, which took effect with an emergency filing that spring and was finalized in October. The rule is straightforward and, from New Hampshire's perspective, outrageous: wages earned by a nonresident who worked in Massachusetts immediately before the March 10 state of emergency, and who is now working from home in another state "due to a Pandemic-Related Circumstance," continue to be treated as Massachusetts-source income subject to Massachusetts personal income tax. The rule is a sourcing rule, not a residency rule, and it runs for the duration of the emergency plus ninety days.

New Hampshire, which has no wage tax of its own, treats this as extraterritorial taxation of its residents. On October 19, Attorney General Gordon MacDonald filed a bill of complaint invoking the Supreme Court's original jurisdiction under 28 U.S.C. § 1251(a), styled New Hampshire v. Massachusetts. The complaint asks the Court to hold that Massachusetts may not impose its income tax on New Hampshire residents whose work is now performed entirely within New Hampshire. The Court has not yet granted the motion to file, and it is not required to; the original-jurisdiction docket is small and discretionary in practice even when the statute reads in mandatory terms.

New York took a different path and largely did not move. New York's "convenience of the employer" rule, codified in the Department of Taxation and Finance's regulations and explained in TSB-M-06(5)I, was already a source of annual friction with New Jersey and Connecticut residents who commute into Manhattan. In Tax Bulletin TB-IT-615 and in guidance reiterated this fall, the Department's position is that a nonresident's wages are New York source unless the work is performed out of state "because of the necessity of the employer," not the employee's preference. A pandemic-driven relocation, in New York's reading, is an employee convenience. New Jersey, whose residents are now working from Hoboken living rooms rather than Midtown offices, has asked whether a pandemic closure of the physical workplace counts as employer necessity. The answer from Albany, as of this writing, is no.

New Jersey has offered a credit for taxes paid to New York under N.J.S.A. 54A:4-1, which partially neutralizes the double-tax exposure for the individual filer. It does not neutralize the revenue shift. Every dollar New York keeps taxing is a dollar New Jersey has to credit, which is why New Jersey Treasurer Elizabeth Muoio has said publicly that the state is considering joining a brief in the New Hampshire action.

Pennsylvania's reciprocal agreement with New Jersey, maintained under 61 Pa. Code § 109.8, survives; a New Jersey resident working remotely for a Pennsylvania employer remains taxable only in New Jersey, and vice versa. The Maryland-Pennsylvania reciprocal agreement and the Maryland-Virginia-DC compact similarly keep functioning for the roughly six jurisdictions that had the foresight to sign them. Where reciprocity exists, the pandemic produced a shrug. Where it doesn't, it produced litigation.

Connecticut, which shares a border with both New York and Massachusetts, is the state most exposed on both sides. The Department of Revenue Services issued OCG-10 in September, noting that Connecticut will continue to treat a Connecticut resident working from home for an out-of-state employer as a Connecticut worker for withholding purposes, and will offer a credit for taxes paid to another state that insists on sourcing the wages to itself. That is the only coherent position available to a state caught between a New York that won't let go of its commuters and a Massachusetts that has just grabbed a new set.

Why UDITPA doesn't answer the question

Corporate income-tax apportionment is a different problem, and in some ways a worse one. The Uniform Division of Income for Tax Purposes Act, drafted in 1957 and adopted in some form by roughly two-thirds of the states, apportions business income among states using three factors: property, payroll, and sales. UDITPA § 13 defines the payroll factor as compensation paid "in this state," and § 14 defines compensation as paid in a state if the service is performed there, or if the service is performed both in and outside the state with the base of operations in the state, or if there is no base of operations, where the employee's residence is.

Run that test against a software engineer who used to work in a San Francisco office, is now working from her parents' house in Boise, and whose employer has no Idaho property at all. Under a strict reading of § 14, her compensation is Idaho payroll for apportionment purposes, because Idaho is where the service is performed. The employer has no Idaho property and may have no Idaho sales. The payroll factor alone is now pulling a sliver of the California corporation's income into Idaho's apportionment formula, and Idaho has no prior tax relationship with that corporation at all.

States have largely not confronted this. The Multistate Tax Commission's model regulations, and the RIA-style treatises that practitioners actually use, still describe the payroll factor as tracking where services are performed. Most of the state Departments of Revenue that issued pandemic guidance limited themselves to personal income tax withholding and said nothing about corporate apportionment. New Jersey, Massachusetts, Pennsylvania, and a handful of others published notices saying that the temporary presence of a telecommuting employee in their state during the emergency would not, by itself, create corporate income-tax nexus or alter the apportionment factors. Those notices are time-limited and tied to the state of emergency. None of them answers what happens when "temporary" becomes the new baseline.

The sales factor, which in most states is now the dominant or only factor under market-based sourcing, partly absorbs the problem. A California company selling SaaS to New York customers apportions to New York on the sales side regardless of where its engineers sit. But states that still use three-factor apportionment, and every state for any property or payroll factor that remains in the formula, face the same structural mismatch: a statute that asks where services were performed, answered by a workforce that answers "everywhere, and nowhere in particular."

The federal piece, such as it is

Federal telework guidance has been operational, not tax. OMB Memorandum M-20-17, issued March 17 by then-Acting Director Russell Vought, directed federal agencies to maximize telework for the federal civilian workforce and to extend telework flexibilities to contractor personnel where feasible. It is a workforce-management directive, not a tax rule, and it does not address state withholding for federal employees or contractors who have relocated. A federal contractor whose W-2 address has moved from Virginia to Tennessee during the emergency has the same state-tax sourcing problem as any other employee, and the OMB memo does not resolve it.

Legislatively, the Remote and Mobile Worker Relief Act (H.R. 5674 in the 116th Congress, with a Senate companion in S. 3995) would impose a uniform thirty-day threshold before a state may tax a nonresident's wages, with a pandemic-specific extension to ninety days for 2020. It has sat in committee since March. The S corporation, LLC, and partnership worlds have their own analogous bill in the Mobile Workforce State Income Tax Simplification Act, which has been reintroduced in every Congress since 2011 without passing. Federal preemption is the obvious answer to this mess, and Congress has so far declined to provide it.

What to do between now and whenever this settles

For employers, the practical exposure is withholding. Running payroll for an employee who has moved from State A to State B means, at a minimum, registering as an employer in State B, opening a withholding account, and reporting wages to both jurisdictions if either state is going to claim them. Where a reciprocal agreement exists, the employer files a single state's withholding and the employee signs the reciprocal exemption form. Where one doesn't, the employer withholds for the work state (or for both states, at the employee's request via the resident state's credit claim), and the employee takes a credit on the home-state return at filing.

The cost of getting this wrong is not theoretical. Failure to withhold exposes the employer to the tax, plus penalties that in most states run from 5% to 25% of the underwithholding, plus interest. A company that has let a dozen engineers scatter across eight states without updating its payroll provider has created eight state-tax registrations worth of back-filing, and the clock has been running since March.

For employees whose employer is in an aggressive sourcing state, the tactical question is whether to file a nonresident return claiming a refund. A New Hampshire resident formerly commuting to Boston who has not set foot in Massachusetts since March has a strong argument that her 2020 wages are not Massachusetts-source, notwithstanding TIR 20-5. Filing that return, paying tax to Massachusetts under protest, and then watching the Supreme Court docket is the posture a careful tax advisor recommends this fall. Whether the Court takes the New Hampshire case, and whether it reaches the substantive sourcing question or resolves on jurisdictional grounds, will shape the refund posture for a much larger class of filers than the parties themselves.

The longer problem is the one nobody on the state side wants to say aloud: if remote work sticks, the apportionment formula has to be rewritten, the "convenience of the employer" rule has to be rewritten or retired, and the sourcing rules in UDITPA § 14 have to decide whether they are about the employer's base of operations or the employee's kitchen table. The statutes that govern this were drafted for a workforce that commuted, in an economy where "where services are performed" and "where the employer is" produced roughly the same answer. They do not produce the same answer anymore, and the states that benefit from the old answer are not going to volunteer the new one.

Sources

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