Our company is based in New York City, but since March 20 our employees have been teleworking because of the “stay at home” orders necessary to combat the spread of COVID-19. Most of our employees are working from their homes in New York, New Jersey, and Connecticut. However, one employee was visiting his parents in Mississippi when the order went into effect, and so is now teleworking from that state. Our company had not operated in states other than New York before the pandemic hit. Now that we have employees working from these additional states, will we be required to report them to those states for unemployment tax purposes or withhold income taxes? Also, employees must use their cell phones for work now that they’re away from the office. Some employees are asking whether they can expense cell service and internet upgrades. Is this something our business must cover?
—Quarantined in Queens
The good news is your employees are safe and most can work from home. Now for the bad news. There are no quick and easy answers to your questions, because the tax laws vary by state and each employee’s situation. Let’s break your questions down by the unemployment insurance, income tax, and business expense issues that arise in your situation.
When employees work remotely in states other than where the office is located, an employer has to decide: (1) the proper state to report and pay unemployment insurance and other state payroll taxes; and (2) whether to withhold state income tax withholding. Payroll taxes are paid to only one state, and all states use the same four-part test:
1. Localization of services;
2. Base of operations;
3. Place of direction and control; and
4. State of employee’s residence.
This test must be applied in hierarchical order; that is, an employer must first determine if the work is localized to a particular state. An employee’s services are “localized” in a particular state if all or most of the employee’s services are performed in such state, with only incidental services performed elsewhere (for example, where the out-of-state service is temporary or transient in nature or consists of isolated transactions). Where the services performed outside of the state are either permanent, substantial, or unrelated, it cannot be treated as localized to a particular state. In many cases, it is clear that services are localized in a particular state. If so, that is the end of the analysis.
If an employee’s services are not localized to a particular state (because, for example, they spend 33% of their time in three separate states), then the next step is the base of operations test, which focuses on the place the employee customarily returns to receive instructions or supplies, to repair equipment, or to perform other functions relating to the provision of services.
If the employee’s services are neither localized, nor subject to a base of operations, the third test is the place of direction and control, which is often a corporate or regional headquarters where the employee gets instructions. If none of the previous three tests provides a clear answer, then unemployment insurance taxes are due to the employee’s state of residence.
Here, because it is assumed that your employees are temporarily sheltering in place until the government says it is safe to return to normal work locations, it seems reasonable to assume that services will continue to be localized in the original work state. Thus, for now, you presumably could continue to report all your employees to New York for unemployment tax purposes. If the stay at home order continues for longer than six months, you might want to revisit the issue and reconsider whether another state is the correct state to report employees. Hopefully, everyone will be back to work long before then.
Unlike unemployment insurance taxes, which are paid to a single state, income taxes may be paid to several states. Thus, when an employee works in more than one state, an employer may be obligated to withhold and remit income taxes to each relevant state. The states have very different rules about when income taxes may be withheld. For example, New York and Connecticut both have a 14-day rule that states if an employee is working in the state for 14 days or less per year, then there is no income tax withholding. New Jersey and Mississippi use dollar thresholds. In addition, some states have reciprocity agreements that eliminate income tax withholding. For example, if an employee lives in New Jersey but works in Pennsylvania, the employer is not required to withhold Pennsylvania income taxes under an agreement between New Jersey and Pennsylvania.
In your case, for your employees working in Connecticut, more than 14 days have passed, which would—under the general rules—obligate you to register as an employer and withhold and remit Connecticut income taxes. Whether the same obligation exists in New Jersey may depend upon whether the particular employee meets the dollar threshold.
For your employee working remotely from Mississippi, fortunately on March 26, 2020, the Mississippi Department of Revenue addressed this issue in guidance by stating that it will not change withholding requirements for businesses based on the employee’s temporary telework location or impose any new withholding requirements on the employer. Thus, for the present time, there is no income tax withholding obligation there.
These issues remain fluid, and you should consult state tax departments regularly for any updates to their withholding rules in light of the current pandemic.
Turning to your business expense question, some states require employers to reimburse their employees for business expenses—but most do not, including the states at issue here (except that in New York, expenses incurred on behalf of the employer cannot take the employee’s wages below minimum wage).
If a business chooses to reimburse workers for business expenses, it can do so on a nontaxable basis if the employee substantiates the business purpose and nature of the expense, usually by way of an expense report with receipts that is submitted within a reasonable period of time, and is only reimbursed the exact amount claimed. Alternatively, an employer can reimburse employees a flat amount without regard to actual expenses. In such cases, the expense reimbursement is taxed as a wage for federal and state tax purposes.
In IRS Notice 2011-72, the U.S. Internal Revenue Service announced that personal use of employer-provided cell phones would be tax-exempt to employees if the following factors were met:
1. Maintenance of phone is reasonably related to the needs of the employer’s business, which includes being able to reach employees in emergencies or having to reach clients after hours;
2. Reimbursement has been reasonably calculated to not exceed the employee’s expense of maintaining the phone;
3. The reimbursement for business use is not a substitute for a portion of the employee’s regular wages; and
4. The reimbursement arrangement doesn’t replace a portion of employee’s previous wages (i.e., disguised compensation).
After this guidance came out, the IRS clarified that the same rules apply to employee’s use of their own cell phones for business purposes. So, according to the IRS, reimbursing employees for the reasonable expense of using their personal cell phones may be made on a non-taxable basis. The same should be true for internet service, although it is important to recognize that not all use of home internet is a business expense, and so some allocation of a reasonable amount to reimburse for the business use, as opposed to just paying employees’ internet bills, must be made. This assessment typically requires employers to make reasonable inquiries regarding costs and business usage.
In sum, Quarantined, based on your question, for now you likely can continue to report your teleworking employees to New York for unemployment tax purposes, but will need to register as an employer and withhold and remit income taxes in at least one other state in which your employees are currently teleworking. With respect to your business expense question, there are different ways to reimburse employees for using their personal devices for work purposes, so you need to decide whether you want to just provide a flat amount per week or month to employees to cover expenses while they work at home and not worry about receipts, or want to make the payments nontaxable and collect the necessary information and documentation to ensure payment of no more than covers the business expenses.
We wish you and your employees the best as we get through this crisis.