Timothy Noonan of Hodgson Russ LLP discusses how some states tax remote employees and the effect of temporary pandemic tax changes.
This transcript has been edited for length and clarity.
David D. Stewart: Welcome to the podcast. I’m David Stewart, editor in chief of Tax Notes Today International. This week: tax and remote work.
In March 2020 as the world shut down and many companies switched to fully remote work, few were thinking about the tax consequences of all these new teleworking employees. But as the pandemic dragged on, many states put into place temporary tax laws establishing that remote employees would be subject to taxes in the state of their employer, similar to the convenience of the employer rules, which are a policy that’s been around for some time in states like New York and Pennsylvania.
Now, two years later, many companies continue to offer a remote option for their employees. Yet those temporarily enacted pandemic rules are ending, causing many to wonder about the future of tax policy for remote workers.
Tax Notes State reporter Paul Jones will talk more about this in just a minute.
Paul, welcome back to the podcast.
Paul Jones: Thanks, David. It’s great to be back.
David D. Stewart: Now, Paul, I understand you’re one of our fully remote reporters. Where are you based and are you affected by a convenience rule?
Paul Jones: Yes, unlike most of the Tax Notes crew who are based out of Virginia, I actually work out of sunny California all year. Now, Virginia doesn’t have a convenience of the employer rule and that means that my income is taxed only by California where I work. Of course, notably, California also doesn’t have a convenience of the employer rule. Yet, anyway.
David D. Stewart: I understand you recently talked with someone about these rules. Could you tell us about your guest and what you talked about?
Paul Jones: Sure. Our guest expert is Timothy Noonan. He’s a partner in the New York office of Hodgson Russ LLP. He spoke with me recently about the controversy over states’ longstanding convenience rules and also about the potential fallout from these similar temporary withholding rules that a lot of states adopted during the pandemic.
David D. Stewart: All right, let’s go to that interview.
Paul Jones: Thanks for joining us, Tim.
Timothy Noonan: Happy to be here. Thanks, Paul.
Paul Jones: As we know, convenience of the employer rules have been around for a while. I think there’s roughly five states that impose them, depending on how you count which states have a rule. During the COVID-19 pandemic, there was an increased focus on people working outside of their usual areas, including across state lines, and there was an increased attention focused on convenience of the employer rules.
Before we jump into that, can you give us a quick review of these rules, where they came from, what their original purpose was, and how they’ve evolved since? Also, what are some of the challenges they pose? Why have these been controversial over the years?
Timothy Noonan: Sure, Paul. The convenience rule was historically built into the tax law of a handful of states. New York pretty much being the most notable because the issues seemed to arise most in the New York courts and in New York tax audits.
The genesis originally was really one around tax avoidance or curbing tax avoidance. States like New York didn’t want taxpayers who lived in a border state like New Jersey or Connecticut to get some sort of tax benefit by simply not going to work. If the employee could save a couple percentage points in income tax by staying home instead of commuting into work on a particular day, that to the New York legislators and tax department folks seemed like an unfair advantage to people who lived in New York and commuted from their house down the street.
That was the initial rationale behind these rules. Like I said, there wasn’t lots of action in this in states outside of New York. In New York this became a hot button issue in part because of New York being a financial center, a commercial center, and being right on the border of a couple other states, and in part because New York took a pretty broad interpretation of what the convenience of the employer rule really meant.
The convenience of the employer rule basically says that, “If you’re working from home for your own convenience and not out of any employer necessity, the state’s going to treat that day as a day worked in New York.” So, New York cases started to come out and New York was taking a very broad interpretation of what was a convenience day. Then they extended this, in some other cases, beyond just local telecommuters to people who were working remotely from across the country.
That sort of led to this genesis. All of this, of course, is pre-COVID-19.
But even pre-COVID-19, the challenge was the inconsistency in the rules because only a handful of states had these rules and the states right immediately around New York, like New Jersey, Connecticut, and Vermont, didn’t have these rules. The big problem a lot of times was double taxation.
That was actually the case in Connecticut for years. Connecticut didn’t have a convenience rule, historically, so if we had a telecommuter that paid tax in New York, Connecticut wasn’t giving their residents a credit for that. That caused lots of challenges for employers and employees and led to a lot of the old controversy. This ended up getting fixed by Connecticut in 2019, but it still could have come up in a lot of states.
Pre-COVID-19, before everyone started telecommuting much more, there already was brewing controversy. It just was pretty limited to New York and environs because most states didn’t have the rules and telecommuting wasn’t as prevalent.
Paul Jones: Right. Now let’s talk about some of the challenges that have come up because these rules are asserting the right of a state to tax someone who’s working outside of their jurisdiction, and so there have been some legal challenges. We’ve had a lot of people speculate or assert that these rules could or do run afoul of the Constitution. But the challenges to these rules on those grounds have not been successful.
Can we discuss a couple of those? In particular, obviously, we’re going to talk about Zelinsky v. Tax Appeals Tribunal of New York and Huckaby v. New York State Div. of Tax Appeals.
Timothy Noonan: Sure, and those cases are 15 or 20 years old at this point. But both of those taxpayers brought, as you said, constitutional challenges to New York’s convenience rule on a couple different grounds. One sort of on a commerce clause ground that there was double taxation. Clearly, that was the issue with Professor Edward Zelinsky, who lived in Connecticut and was subject to the double taxation issue I mentioned a minute or so ago.
Mr. Thomas Huckaby didn’t live nearby in New York. He lived down in Tennessee but was a remote worker for a software company. His challenge wasn’t really based on double taxation because there’s no income tax in Tennessee, but on more of a due process type ground that it just didn’t seem right that constitutionally New York was able to use its long arms to tax someone who was working in another state like that.
Well, again, both of those taxpayers lost. Those cases went to the Court of Appeals in New York, which is New York’s highest court. The Supreme Court denied taking either appeal. It’s been the law of the land in New York for at least the past 15 years or so.
There was also around this time period lots of other litigation in New York’s administrative courts, in New York’s Division of Tax Appeals where taxpayers were trying to defend themselves against some pretty aggressive positions taken by the New York Department of Taxation and Finance on this convenience rule.
There were some cases where an employer asked the taxpayer to work at home because they didn’t have enough space for them in their office. Or they asked the taxpayer to work at home because their job was of a confidential nature and they didn’t really feel like they had the privacy systems in place at the office to protect client information or whatever.
In cases like that, taxpayers kept losing. The courts were saying, “Well, look. The work that this employee is doing is of the nature that it could have been done in New York, so even though their employer asked them to stay at home, we still think that it’s a convenience day.”
That seems to throw the whole concept of the convenience rule on its head. The convenience rule says that if you’re working from home for your own convenience and not for employer necessity, then that’s treated as a New York work day.
A lot of these cases seem to employ a much broader interpretation. The idea being if the work was of the nature that it could have been done in New York, well, then New York should be able to tax it even if the work was done at home.
In addition to the constitutional issues that we saw come up in Huckaby and Zelinsky, these other administrative cases really made it difficult on the legal issue for taxpayers to win. New York was taking a real broad interpretation of the rules and they were winning.
Paul Jones: We came almost to maybe a homeostasis and then COVID-19 hits and you have lockdowns in an attempt to control the spread of the virus and people start working from home, including out of state. A whole bunch of states come under pressure to issue tax rules to address withholding nexus, etc.
The reason we’re talking about this is that some of the rules by these states, I think most notably Massachusetts, function like a convenience rule. They don’t specifically state that if you’re working from home for convenience in a different state, then they’re still going to tax your income.
Rather, to both protect their revenue and for purposes of simplicity for employers, they said, “If a person normally works in this location, in our state, keep withholding for them.” Of course, this isn’t universal. States all had different variations.
But they established all of these rules that asserted this right to tax someone who was no longer doing work in that state. These were temporary rules, but presumably there are going to be audits of workers for this period that come up. They may be appealed and potentially even litigated.
I’m curious, leaving aside the larger constitutional questions about convenience rules, do you think that some of these pandemic era rules, if they are challenged, are going to stand up? Or are there going to be issues like whether there was statutory authority for a tax department to issue this rule without new legislation to enable it?
Timothy Noonan: Yes, I do expect there to be litigation. What’s interesting is of the 30 or so states who came out with some pandemic level guidance on this issue, it was not at all uniform.
A number of states didn’t employ something like a convenience rule. A number of states said, “You know what, if you’re physically working in our state, well, that’s a work day in our state. We don’t care that you’re working remotely for your employer who might be in New York or Connecticut or California.”
You not only had states coming out with this emergency guidance, but you had it being different. I think at one point when we were tracking it closely, 16 states had said, “Use a convenience type rule,” and 15 states said, “No, we’re going to use a physical presence rule.”
I think on the constitutional basis, Massachusetts already won its dispute with New Hampshire, or at least the Supreme Court refused to take their case. Whether or not other taxpayers can make a constitutional claim against a state who put in one of these emergency rules, that’s open to question. I’m not sure.
But the issue around whether or not the tax departments were even authorized to issue these emergency rulings, I think is a really good one. It just reminds me of the airport mask mandate that got thrown out.
All these mandates are getting thrown out, not based on testimony by doctors. They’re being thrown out because the administrative agencies in the federal government or the states just didn’t have the power to do it. You definitely could see that as an avenue for taxpayers to challenge some of these rules.
Paul Jones: Another thing about the pandemic era that I think is interesting is most of these states were coming out with these rules ad hoc to try and address the situation. But of course, you also have states like New York, which has an on the books convenience rule. I believe that New York is either auditing or is expected to audit workers during the 2020 year, the 2021 tax year, etc., and will presumably apply its convenience rule in places it thinks that it should apply.
In a situation where someone is working out of state because of concern about COVID-19 or because their employer’s concerned about COVID-19, or even in response to a lockdown order, if a state’s trying to impose its taxation on that person for working out of state under their convenience rule, does the context of the pandemic and the desire of people to avoid infection cut into the state’s ability to argue that working remotely is from convenience?
Timothy Noonan: Well, New York doesn’t think so. Shortly after all these lockdowns started, New York issued some guidance on their website that basically said, “Status quo. Even if you’re working remotely as a result of a lockdown or your employer asking you to work from home, that doesn’t matter. The normal convenience rules still apply.” Now, whether that holds up is another story.
I’ll tell you, Paul, you mentioned auditing by New York. New York did something pretty remarkable or unusual last year and it continues. Lots of taxpayers who filed their taxes in April or May of 2021 for the 2020 tax year or in October of 2021 for the 2020 tax year, they got an audit notice right away. In some cases the next day, immediately issued.
These weren’t the typical residency audits or field audits that we see on a regular basis that New York state runs. These were more what we call desk audits, meaning it was almost like a computer generated notice issued to a taxpayer immediately after filing.
A normal audit would come a year or so after someone files a tax return. These desk audits were coming a week or so after the tax return was being filed. They’re all the same. It was the same letter and it was indiscriminate. I saw one where a taxpayer reported $10,000 of income and got one of these notices and some who reported $10 million of income and got one of these notices.
They came out with this program, all asking questions around the convenience rule. The issue that we’re going to face is that does the context of the argument change when someone’s working from home as a result of a government order? Let’s say if the government shut down the office and said everyone had to work from home, how could New York sustain a position that that was a convenience day? It seems awfully inconvenient and it definitely seems like someone’s working from home in that situation based on necessity.
Similarly, even after a lot of these government mandated shutdowns went away, later in the spring or summer of 2020, lots of employers, particularly in New York City, said, “You know what, why don’t we just stay closed? It seems to be working, people are still concerned, so don’t come in.” Lots of companies just locked their doors. No one could come in. Some companies made it optional. But most people were told to stay home.
That adds a wrinkle to the whole convenience rule analysis. Many of the states who put in these temporary rules didn’t really use the convenience tag. They just said, “Look, if you used to work in our state and then the lockdown happened and you’re working remotely somewhere else, we’re going to treat that as a day worked in our state.” That was the Massachusetts rule.
But New York is married to its convenience rule concept, and I think to your direct question, there’s just a different analysis that could be applied here. If you have the government shutting down your office, you have your employer shutting down your office. The taxpayer, I think in that case, has a really good argument that this isn’t a convenience day whatsoever. This is a necessity day. “I was working from my home in New Jersey or my parents’ basement in Florida, I was doing that out of necessity. I couldn’t go in the office, for crying out loud.”
That definitely is going to add a wrinkle to the legal arguments here for sure.
Paul Jones: Let’s move forward, though, because that’s the fallout from this particular period of time. In many instances, unique circumstances where people were working from home because they’re concerned about the virus or their employer’s trying to deal with the fallout from this pandemic and all of these countermeasures being taken to control the spread of it.
But we’ve also seen, now that we have higher rates of vaccination and lower rates of hospitalizations, something resembling a return to, if not normalcy, at least an acceptance of the endemic phase of the COVID-19 pandemic. As that has happened, what people are observing is apparently there has been an acceleration of what was a pre-existing trend towards increased telecommuting. It seems to have increased significantly and on a permanent basis.
We’re probably going to see more and more people, particularly those whose work model allows them to work from home, telecommuting either most of the time, all of the time, or at least part of the time with these flexible work rules that some employers are allowing. As a result of that, it’s interesting to take a look at how that could affect convenience rules.
But I think one of the first questions is, is that going to put an onus on states like New York to increase their enforcement of convenience rules? Also, are other states going to be looking potentially at enforcing or even adopting convenience rules as a means for protecting their tax base?
Is one of the reactions we might see to increased telecommuting going to be stricter enforcement of existing convenience rules and more taxing authorities and legislatures looking at enforcing convenience rules or creating convenience rules so that they can go after mobile workers?
Timothy Noonan: Yeah, certainly on the enforcement question, for sure. Especially in a state like New York.
New York really literally can’t afford it. They can’t afford losing the revenue from all of the folks who are now on a more regular telecommuting model. So, absolutely.
As I mentioned with the new audit program in New York, that’s already being played out in 2020. We’ve seen the same immediate audits for 2021 taxes. Increased enforcement, definitely.
Do we think other states are going to adopt a convenience type rule or a telecommuting rule? Look, there’s winners and losers. Some states will benefit like Colorado. That’s a state where maybe lots of people will or have gone to hang out and work remotely. They might not want a convenience rule because they might have a lot of New Yorkers who are just hanging out in a vacation home working. They’d like to tax those days.
But a state like California is a real good example because California is a physical presence state historically. Meaning that if I work for a company in San Francisco, but they allow me to work remotely and I’m a resident of some other state, then I don’t have to pay California tax on my compensation because I’m not working in California. That could be a big problem for California.
I definitely think you’ll have states that are so-called “losers” in that respect, like California, who are going to need to reevaluate their policies. They’re going to look to establish a rule like New York’s rule to make sure they don’t lose that revenue.
Paul Jones: There may be some larger fights on the horizon over this. But just for now, if you’re an employee or an employer and you’re in a state that has a convenience rule, or maybe your state starts thinking of adopting it, what are some of the practical things that employees and employers should look to do to try and make sure that they have either minimal exposure to this or that they avoid double taxation? Or maybe they just want to avoid being caught with a convenience rule at all and they want to know within the existing rule or rules, what are some of the things they can do to avoid them?
Timothy Noonan: Yeah, it is certainly a challenge for employers right now. There’s a war for talent on so it’s tough to get good people to come work for you.
If you’re in a state that has a convenience rule, like New York, it might be hard to hire someone. You don’t care where that person lives, you’re going to allow the employee to work remotely. They might be coming from Tennessee and there’s no income tax there. That employee’s not going to want to take the job if it’s going to mean 8 percent of income tax on their compensation. That’s a challenge already for employers.
Then, again, avoiding the potential for double taxation that could occur if you have someone who lives in Colorado that has a physical presence rule, but is telecommuting to New York.
Where there’s a will there’s a way, though. We’ve worked with lots of clients to find ways to manage this or frankly, to get around it.
One way, if we’re speaking in the context of New York, is to just not come to New York to work at all. New York’s convenience rule only applies to a taxpayer who’s working sometimes in New York and sometimes not in New York. If you’re a 100 percent telecommuter — you literally don’t come into New York at all for one day during the year — then under some longstanding case law in New York, the convenience rule doesn’t apply. Really interesting there, but it’s an all-or-nothing thing. If you work for one day, then you’re subject to it. But if you don’t come in then that convenience rule doesn’t apply.
That’s a New York specific rule, but certainly that’s one way to manage that. Not always practical. Employers will want their employees to come in sometimes just to see people.
Another way to manage it is if there’s an office in another state. These convenience rules will generally apply if you’re telecommuting to an office inside the convenience rule state.
If I move to Florida and I live in Florida, but I’m telecommuting to an office in New York, then the convenience rule applies. But what if my company opens up an office down the street in Miami and now that office becomes my office? I go there, that becomes my office. Well, OK, I’m not working from home anymore, I’m working in the Miami office, so the convenience rule doesn’t apply. Great.
Or what if my firm already has an office in Palm Beach? I say, “OK, guys. Well, now I live in Miami, can you assign me to the Palm Beach office? I’ll go there sometimes and that’ll be my main office.” Now when I’m telecommuting, I’m not telecommuting to New York, I’m telecommuting to the Palm Beach office. We don’t have to worry about New York’s convenience rule then.
Working on ways to get someone connected to a different office, it’s something companies can do.
We’ve counseled a lot of our clients in setting up arrangements like that. There are facts and circumstances type things. It’s got to be a legit office assignment. The person has to go there at least sometimes. But it’s a definite way around it.
The last thing we’ve worked with companies on, and this goes back to one of my comments earlier about the safe harbor rules that have been put in place in New York to allow home office work if that work is done out of what New York deems to be a bona fide office of the employer. That requires us meeting a laundry list of factors, but if we can meet those factors, then voila, we’ve fixed the issue.
We’ve worked with a lot of companies to set up that type of arrangement, answering to some sort of telecommuting agreement or telecommuting arrangement with their employee and that gets us out of the problem. If someone’s moved to Florida, it means we don’t have to pay any tax. If someone’s moved to Colorado, it means we don’t have to pay double tax.
But there’s definitely ways to manage this or get around it if folks just take the time to figure it out.
Paul Jones: One last question here. When we look at the rise of remote work, let’s say that this continues to be an option that becomes more and more attractive to people. We’re going to have probably a larger constituency of remote workers than we’ve had in the past. As that becomes the case, does that undermine the argument for these convenience rules in a way that maybe affects states within their rulemaking with their legislative process?
We mentioned some states may be winners and losers. There may be some states that have an incentive to try and protect their tax base. But I’m wondering if remote work might also cause people to put pressure on states to say, “Look, this is not a convenience issue and you can take a hard line on this, but we’re going to avoid working in your state or even putting a toe across the border into your state if you’re going to try and tax us like this.”
Over time, it might just make the argument because when we were talking about the genesis of these rules as a means of going after tax avoidance, it increasingly seems like these rules are moving in their application away from that towards just going after people who don’t work at their employer’s office in a given state because that’s no longer a normal work model.
Is there a potential that the justification for and the premise of these rules becomes so weakened over time by the facts on the ground that it becomes harder and harder for states to sustain them?
Timothy Noonan: That’s interesting. I’m not sure. I think the premise that these convenience rules were designed as a way to deter tax avoidance died a long time ago.
Maybe with the Huckaby case in New York, where he wasn’t avoiding New York tax by working over the border, he was thousands of miles away. The premise was states like New York thinking, “Hey, look. If you’re working for a New York company and you’re doing work that could be done in New York, you shouldn’t get a special benefit because your employer allows you to work from home. Whether that’s across the river or whether that’s across the country.”
I think with remote work becoming normal, it’s not that it undermines the premise that supports a convenience rule. I think what it does is it shines a light on the potential inequity of it. It shines a light on different states having different rules that could lead to double taxation. It leads to podcasts like this, where people are talking about it. It spurs action, and when we’re dealing with taxes and tax lawyers, it leads to litigation.
That could upend the rule, which from the beginning is a little questionable. Why should you be able to tax somebody in the state of New York if they’re not working in the state of New York? That always was goofy.
I think what the increase in these remote work arrangements does is it shines a light on an issue that’s unusual and that can be really unfair. That, I think, is what’s going to spur a lot of action, a lot of litigation, a lot of discussion on this for many years to come.
Paul Jones: Well, thanks, Tim. It’s been a real pleasure talking with you, and I’m sure everyone appreciates your analysis on this issue.
Timothy Noonan: Awesome, Paul. Happy to participate. Thanks again.