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INSIGHT: State Nexus Relief Guidance Could Cause Issues for Employers

July 16, 2020, 8:00 AM

The Covid-19 pandemic has forced many businesses to transition from a mostly office-based workforce to a nearly 100% home-based workforce. One incidental state tax effect, absent administrative or legislative relief, is that this home-based workforce may cause some businesses to have additional state and local income tax filing obligations and payment requirements in states where they previously have not had nexus. Moreover, once the crisis abates and these employees return to their office locations, businesses may have state tax attributes, such as net operating losses or tax credits, assigned to the employees’ home office locations, which may become stranded and unavailable to fully offset the businesses’ income in later years.

In the wake of this pandemic and resulting work-from-home (WFH) orders, some states are providing relief for taxpayers whose employees were forced to work from home due to the Covid-19 emergency. However, the number of states that have provided such guidance is limited, and the guidance provided is often lacking in clarity and not uniform. As of the date of this article, only 15 states and the District of Columbia have issued such guidance. The majority of states have issued no guidance on the tax implications of WFH orders. Therefore, businesses may be subject to new income tax filing requirements and potentially increased taxation in states based on the presence of WFH employees in certain states. Businesses may see dramatic differences in their state tax profile for the year the WFH orders are in place and beyond.

For reasons similar to those addressed in this article, the presence of employees working from home could create numerous state and local tax obligations for affected employers, including additional or expanded state income tax withholding, payroll, and sales and use tax obligations. Our focus in this article is solely on the state income and employer withholding tax effects of the WFH orders on businesses, and such other tax considerations are outside the scope of this article.


In general, a company that has employees working in a given state has long been considered to have nexus with that state and is thus subject to that state’s income tax filing, withholding, and payment requirements. In determining the amount of income subject to a particular state’s taxes, an apportionment formula is applied to determine the proper share of the company’s business income derived from that state. Most states use either a three-factor formula based on a proportion of the business’s property, payroll, and sales in the state compared with everywhere else, or a single-factor formula based solely on sales to determine the amount of business income apportioned to the state.

In response to the pandemic, the majority of states and the District of Columbia issued mandatory WFH orders to limit the spread of Covid-19. As of June 30, 2020, six states (i.e., Arkansas, Iowa, Nebraska, North Dakota, South Dakota and Utah) have not imposed any WFH orders. Most states have begun to reduce these WFH orders to “safer-at-home” orders or otherwise have begun to lift restrictions in phases. Even as employees begin a phased return to their office locations, it is expected that employees who have been working from home in a state other than the state of their employer’s office will continue to WFH in some capacity.

The presence of WFH employees could clearly affect the calculation of the payroll factor when computing apportionment in a given state, but it may affect the calculation of the other factors, as well. For example, the presence of inventory or other employer-provided property, such as employer-owned or -leased computers and printers in an employee’s WFH location could affect the computation of the employer’s property factor.

In addition, for those WFH employees engaged in a service business or the sale of intangible property, the sales factor for their employers could be increased in states that source sales from services based on a cost-of-performance (COP) basis. The COP methodology sources sales from services to a state based on the location where the income-producing activity generating the sale occurred. So, in a simplified example, an employee working from home and generating sales for his or her employer could potentially lead to a sale being sourced to the location of the employee’s WFH state. Note, however, that not all states use a COP method to source sales from services; the majority of states source sales based on a market method, meaning that sales are sourced to a state where the services are delivered or received. The presence of an employee working from home in a market-based sourcing state, therefore, generally would not affect the employer’s sales factor.

However, market-based sourcing states are still an important consideration of the WFH apportionment impact analysis. Even businesses that do not have WFH employees could be affected if a WFH order is imposed on their customers in a market-based sourcing state. Taxpayers may be required to adjust their sales factor sourcing based upon where their customers’ (i.e., the employers’) WFH employees are located, potentially altering their sales factors. Moreover, these taxpayers may find themselves subject to additional state tax filing obligations because the very same WFH use of their products or services by their customers’ WFH employees could create nexus or exceed their “doing business” standards.

Covid-19 pandemic and state nexus guidelines

In response to these anomalies of employee presence due to state WFH orders, a number of state revenue departments have issued guidance clarifying whether they will assert income tax nexus for businesses with employees working from those states due to the Covid-19 emergency (cumulatively referred to as nexus relief guidance). As of June 30, 2020, Alabama, Georgia, Illinois, Indiana, Iowa, Maryland, Massachusetts, Minnesota, Mississippi, Nebraska, New Jersey, North Dakota, Pennsylvania, Rhode Island, South Carolina, and the District of Columbia have issued various guidance on income tax nexus, withholding, and income sourcing for out-of-state businesses whose employees are working in one of these states in response to WFH orders. While Idaho has not issued any official nexus relief guidance, representatives of the Idaho State Tax Commission have advised that the state will enforce its nexus rules in connection with WFH orders on a case-by-case basis.

Almost all of the states that have issued nexus relief guidance to date have provided that the tax authorities will not consider the presence of one or more employees telecommuting from the state due to WFH orders to be sufficient to create nexus. Certain states’ nexus relief guidance also clarifies that compensation paid to employees telecommuting or property used for WFH employment due the Covid-19 pandemic will not be included in the payroll or property factors, respectively.

Even though this nexus relief guidance has some commonalities and generally eases the compliance and tax burden for out-of-state companies, it is important to pay close attention to each state’s specific guidance as it may have different expiration dates or otherwise provide selective relief. For example, the Massachusetts nexus relief guidance (TIR 20-5) is only valid for the duration of the Massachusetts Covid-19 state of emergency, while Indiana’s nexus relief guidance (IN DOR, COVID-19 FAQs) is valid during the periods of federal, state or local WFH orders, a physician’s order related to Covid-19; or actual diagnosis of Covid-19 plus 14 days. In this case, Indiana’s nexus relief guidance may remain in effect even after the expiration of Indiana’s own state of emergency.

Indiana’s guidance also explicitly notes that if an employee remains in Indiana after the temporary remote work requirement has ended, nexus may be established for the taxpayer. In the guidance from other states, this is only implied. For example, Maryland had initially stated that it will not change the method of determining nexus or income sourcing, but it would “consider the temporary nature of businesses’ interim workplace model” in making a nexus determination and whether income was sourced correctly to the state (MD Tax Alert 04-14-20B). However, the Revenue Administration Division of the Office of the Comptroller of Maryland later updated its guidance to clarify that it will “recognize the temporary nature of a business’s interim workplace model ... and will not use these temporary measures to impose nexus [or] alter the sourcing of business income”(MD Tax Alert 05-04-20).

The remaining states, which make up the vast majority of states that impose an income tax, have not issued guidance or have only informally indicated that they will review nexus on a case-by-case basis. In these states, the presence of WFH employees could, at a minimum, create nexus and, thus, a filing obligation for out-of-state taxpayers. An income tax liability may be due in these states if the state uses a three-factor apportionment formula, where property utilized by WFH employees and compensation paid to employees who are telecommuting during the Covid-19 pandemic would impact the property and payroll factor numerators, respectively, in that state. As discussed in the previous section, the sales apportionment factor also may be affected when the compensation paid to a WFH employee is used to source the employer’s sales from services to the employee’s home state based on COP or the taxpayer’s customer is WFH in the state. It is also important to note that none of the nexus relief guidance issued to date has addressed whether the employment-level requirement during the Covid-19 emergency would alter the availability of employee retention credits, which, generally speaking, require eligible companies to maintain a certain number of employees in the state.

Some of the nexus relief guidance also addresses whether income tax withholding is required for employers whose employees WFH in a state in which the employer does not have business operations. Absent relief to the contrary, most states will generally assert that when work primarily is performed from an employee’s home, the employee’s home is a regular place of business. Accordingly, state resident income tax withholding and other employment and business taxes (e.g., unemployment insurance and sales and use tax) apply in the state of the employee’s home. Furthermore, WFH may trigger local payroll taxes in the employee’s WFH location (if different from their residence, such as working from a vacation home, a relative’s home, etc.) that otherwise would not have applied.

Some states’ nexus relief guidance, such as that provided by Mississippi, provides that employers will not be required to withhold income tax from a resident employee working from home due to Covid-19 if the employer does not otherwise have nexus in Mississippi. The nexus relief guidance issued by Massachusetts provides income tax withholding relief for employers of Massachusetts residents who generally perform services outside the state and, likewise, requires the continued withholding on nonresidents who performed services in Massachusetts immediately prior to the Covid-19 emergency.

While states have not yet been aggressively asserting nexus due to WFH employees during the Covid-19 pandemic, it is certainly possible for them to do so to recoup lost revenues from the pandemic. Consider, for example, New York Governor Andrew Cuomo, who expressly stated that the state will not, absent the receipt of federal aid, relax its nexus and doing-business standards for out-of-state workers, including health care workers, working in New York in response to the Covid-19 pandemic.

Increased taxation implications of nexus relief guidance

While all nexus relief guidance issued to date is intended to provide relief for out-of-state taxpayers due the Covid-19 emergency, one could easily imagine a scenario where, in fact, such guidance would cause undue burdens on multistate taxpayers.

Scenario 1:Where an employer’s state and WFH employee’s state both issued nexus relief guidance:

Assume that both State A and State B have issued guidance indicating that they will not assert nexus or increase the numerators of the apportionment factor due to WFH employees during the Covid-19 stay-at-home orders. Company Y is based in State A, and Company Z is based in State B. Due to the Covid-19 emergency, Company Y’s employees all WFH in State B, and conversely, Company Z’s employees all WFH in State A. Since both States A and B have similar nexus relief guidance, Company Y’s employees working from home in State B would not trigger nexus or change the apportionment calculation for Company Y. Similarly, Company Z’s employees working from home in State A would not trigger nexus or change the apportionment calculation for Company Z.

Scenario 2: Where an employer’s state has nexusreliefguidance and the WFH employee’s state does not:

Assuming the same facts as in Scenario 1, now assume that State B has not issued any nexus relief guidance, whereas State A has. Company Y, whose employees are all working from home in State B, would have income tax filing and employment tax withholding obligations in State B due to the presence of its employees working from home in State B, but it also would have to continue these tax filings in State A due to Company Y’s previously existing nexus in State A. Company Z, however, would not be considered to have nexus in State A due to State A’s nexus relief guidance.

First, let us consider the impact on apportionment if both states have a three-factor apportionment formula in place. In State A, Company Y’s apportionment—property, payroll and sales factors—would presumably be unchanged and not decreased to account for the WFH employee workforce working in State B due to the express guidance issued by State A. Meanwhile, its payroll factor in State B would increase from 0% pre-Covid-19 to 100% for the duration of the Covid-19 emergency because its entire workforce is physically working in State B. Company Z, however, would not have nexus with State A due to the guidance issued, and Company Z’s payroll factor in State B would decrease from 100% to 0% for the duration of the Covid-19 emergency.

Let us also assume that State A utilizes market-based sourcing for sales factor purposes and that all sales of Company Y are from services provided to customers located in State A, while State B applies a COP sourcing method and all sales of Company Z are derived from services provided to customers located in State B. In State A, Company Y’s sales, which are sold exclusively to customers based in State A, would be 100% sourced to State A. Meanwhile, since its employees are all working from home in State B, which calculates the sales factor based on a COP method, Company Y’s sales also could potentially be 100% sourced to State B because the services are all being performed in State B. Conversely, for Company Z, there would be no sales sourced to State A since all of its customers are receiving the benefit of its services in State B, and Company Z also would not have any sales sourced to State B since all of its income-producing activities would occur outside State B.

Finally, let us also assume that State B had a retention tax credit, which required the continued employment of a certain number of employees in State B in order to qualify for the credit. Company Z, whose employees WFH in State A, could fail to meet the employee employment levels in State B as a result of the WFH orders. However, Company Y, whose employees all WFH in State B, could potentially qualify for income tax credits in State B, especially if its employees continue to WFH in State B after the Covid-19 emergency orders are lifted.

As these relatively simple scenarios illustrate, taxpayers could be adversely impacted by some states issuing nexus relief guidance, while others could benefit. Taxpayers in such circumstances would need to consider whether there is any potential relief from distorted apportionment or double taxation, whether by requesting state tax departments to consider their unique situations on a case-by-case basis or by seeking alternative apportionment methods.

Massachusetts is an example of a state where it is unclear whether a taxpayer based in the commonwealth with employees working from home outside the commonwealth for the duration of the Covid-19 emergency would continue to calculate its apportionment as though these employees are continuing to work in Massachusetts, or whether the taxpayer could, despite the Covid-19 nexus and apportionment guidance, reduce its apportionment factor numerators due to the WFH employees for the duration of the Covid-19 emergency.

Employment tax implications of nexus relief guidance

Similar to the concerns enumerated above for income tax, employers also have significant concerns regarding how to handle income tax withholding and unemployment insurance for employees working from home. While a few states have issued guidance on the sourcing of wages and the associated withholding, the vast majority have not. This discrepancy has employers concerned about how to comply with existing state and local tax laws when they may have been an employer only in a relatively small number of states and localities pre-Covid-19.

The failure to issue guidance or the delayed issuance of guidance by state and local tax authorities could potentially lead to significant administrative burdens and compliance tasks for payroll departments, including additional tax account registrations; tax compliance and remittances; the tracking of state governmental orders to determine when to begin withholding new taxes and when to stop; and, of course, the potential downstream business tax implications otherwise discussed in this article.

Employers also must potentially consider situations in which their employees are not working from their residence, but rather a vacation home, a family member’s home or elsewhere, and the tracking of their employees to comply with the existing tax law in jurisdictions in which they are working. Most payroll departments are not presently equipped to handle these additional burdens.

With regard to state unemployment insurance, the sourcing of wages and the corresponding contributions is based upon a uniform definition of employment that was established in the 1950s and adopted by all U.S. states and jurisdictions. Under this definition, employers must consider four basic factors when determining employment coverage (listed in order of importance):

(1) the place where work is localized,

(2) the site of the employee’s base of operations,

(3) the employee’s place of control, and

(4) the employee’s residence.

Once a factor of the test has been satisfied, no further review of other factors is required. For the 2020 tax year, many employees will not be localized in any one location due to working from home in a state other than their primary work location, as well as working at their primary work location for a portion of the year. However, the employees will generally have performed some level of services in their base-of-operations state or in the state of their place of control.

Tax implications beyond the Covid-19 emergency

While nexus relief guidance has thus far been helpful in determining a company’s tax compliance obligations during the Covid-19 emergency, the implications of these issues will continue even after the Covid-19 emergency restrictions phase out. Since state guidance issued to date differs on the expiration dates for the nexus relief guidance, businesses and their tax preparers must anticipate equally mixed guidance for when each state reopens and starts lifting WFH orders.

For example, there could be a situation where one state has lifted its Covid-19 restrictions, allowing employees to return to their work locations, while employees residing in this state cannot return to their employers’ offices due to the employers’ states continuing to enforce WFH orders. In this case, employee presence in his or her state of residence, which previously qualified under nexus relief guidance, could trigger income tax nexus and income tax filing and withholding requirements for the out-of-state taxpayer once nexus protections expire.

As the Covid-19 emergency progresses, it is evident that adaptations that employers used to allow their employees to WFH could have far-reaching state income tax consequences. Employees, worried for their health, could stay home even once a state’s WFH restrictions have been lifted, and employers may begin to increasingly rely on a percentage of their employees working from home a few times a week or alternating WFH schedules as long-term options and thereby reduce their office space or close offices altogether. Another consideration for taxpayers who previously had nexus in states due to employee travel is that, post-Covid-19, there may be reduced or even no travel, as businesses and their customers shift to virtual meetings.

All these post-Covid-19 scenarios could lead to very different income tax filing obligations and apportionment calculations, and taxpayers should start tracking where and how often their employees WFH. A nexus study, or even ongoing nexus tracking, may be necessary to determine whether the changes brought on by Covid-19 could lead to mandatory new state filings, reduction in existing filings or recalculation of apportionment factors.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Timothy Mahon is a partner with Ernst & Young LLP in Boston, MA. Tomislav Zovko and Valentina Elzon are Senior Managers with Ernst & Young LLP in Boston, MA and Peter Berard is a Senior Manager with Ernst & Young LLP in New York, NY. The views expressed are those of the authors and do not necessarily represent the views of Ernst & Young LLP or those of the member firms of the global EY organization.