INSIGHT: Tax Considerations for Remote Workforces

The era of the remote workforce has certainly had an impact on commercial real estate, especially in more high-density locations such as San Francisco, Los Angeles, and New York City. The commercial real estate industry has been evolving over the last decade in order to manage the results of companies downsizing spaces due to fewer members of their workforce being located at company offices.

Today’s business environment easily and seamlessly exists and thrives outside of the confines of a single business location with employees and contractors working exclusively from a central office or cubicle. Employees, current and prospective, seek to turn buzzwords such as “flexible work arrangement,” “workplace flexibility,” and “agile working” into reality, and more often than not companies find themselves hiring remote employees and using remote contractors in order to tap into the most-talented resources in prospering markets across the country.

The same trend can have an impact on real estate companies from an internal perspective as they too begin to hire employees or use contractors across jurisdictions to expand their business on a national scale. A real estate company employing an agent, broker, property manager, or the like outside of the state where they are headquartered can subject the company to interstate taxation by creating “nexus.” Nexus refers to a connection or a sufficient physical or economic presence that allows a jurisdiction to legally impose taxes on an entity.

While flexible and remote work arrangements help recruit and retain talent and make for an arguably more satisfied workforce, such arrangements can subject companies to state and local taxation when they previously were not obliged to pay these taxes.

Nexus may be created when a company has people, property (real or personal, owned or rented), and, in many jurisdictions, sales that exceed a specific threshold. Creating nexus in a jurisdiction generally subjects a company to various state and local registration and filing requirements that result in a tax liability, in addition to increasing the cost of compliance when engaging in business activity across state lines.

Complying with various state and local taxation responsibilities generally requires registration with a jurisdiction’s secretary of state, department or division of taxation, and labor department, in addition to any regulatory and licensing registrations that may be required for real estate companies in the various jurisdictions. Depending on a company’s activity within a state, payroll tax, wage withholding, Form 1099 reporting, wage and/or nonresident withholding, gross receipts taxes, net worth, or franchise and income taxes are some of the compliance consequences that companies must evaluate when hiring remote employees or using out-of-state independent contractors.

Payroll Tax

Any time a company hires an employee in a new jurisdiction, management must consider the jurisdiction’s employment laws and the requirements for employers related to payroll taxes, wage withholding, and unemployment insurance. State employment laws and requirements can sometimes differ greatly from federal requirements and result in increased compliance costs. Additionally, using independent contractors may require a company to file state and federal Forms 1099 to report nonemployee compensation and many states have additional nonresident withholding requirements. For example, California may require 7 percent withholding on payments for services performed within California by nonresident independent contractors if the total payments exceed $1,500.

Payroll reporting and taxation can become increasingly complex if property managers, account managers, brokers, or other employees or contractors are managing properties, projects, and/or sales accounts across state lines. State activity, including the physical presence of employees and contractors performing services on behalf of a company, needs to be closely monitored in order to ensure that all payroll reporting and taxation is compliant.

Income Tax

The location of a company’s employees and independent contractors plays an important role in where a company will be subject to income tax reporting and payment requirements.

There exist federal constitutional provisions that impact a state’s ability to subject an out-of-state company to income tax. The Due Process Clause and the Commerce Clause provide that in order for a state to constitutionally impose income tax on an out-of-state business, there must be a minimal connection, or nexus, between the state and the company it is seeking to tax. In many cases, an employee or independent contractor performing services on behalf of a real estate company will give the company nexus in the jurisdiction where services are performed on the basis of physical presence.

In 2002, the Multistate Tax Compact (MTC), an advisory compact that includes state officials, legislators, administrations, and other leaders that seeks to “promote uniformity or compatibility in significant components of tax systems,” developed the concept of “factor presence nexus.” Factor presence refers to a company’s in-state property, payroll, or sales activity (an amount based on dollars within and without a state), which are used to compute a percentage that states use for apportionment of income. Factor presence defines substantial nexus as $50,000 of property or payroll, or $500,000 of sales, or 25 percent of total property, payroll, or sales within a state. A bright line threshold when applied to gross receipts alone is also known as “economic nexus.” These thresholds are adjusted annually for inflation.

Currently, 16 states are members of the MTC and an additional 33 states are either sovereignty members or associate members; 49 states have either enacted the MTC into their state laws or support and participate in the mission of the MTC and/or cooperate with the MTC.

Since 2002, 11 states have formally enacted some form of factor presence or economic nexus standards into law and more states continue to analyze the impact that adoption might have on their jurisdiction’s revenue.

Use of Payroll Agencies or PEOs

In a recent and growing trend, many companies have begun utilizing payroll agencies to handle their HR department and hire employees. While this practice is a great resource for companies that don’t have the internal resources to establish in-house HR departments or deal with HR-related matters, these arrangements do not protect a company from state income tax nexus. Under professional employer organization (PEO) arrangements, a PEO firm might legally employ a company’s human resources outside of the company. However, these employees still perform services on behalf of the company and the employees’ time is still generally 100 percent devoted to the same business activities as if the company was employing them directly. It is important to understand that use of a PEO firm to hire employees does not eliminate the responsibility of the company to assess nexus based on employee location and determine if income tax filings are required.

Non-Income-Based Taxes

Conducting business activity within a state, including the existence of a remote employee there, can also subject a company to non-income-based taxes that could result in a cash tax expense even if the company has book or taxable net operating losses. Jurisdictions such as, but not limited to, Ohio, Washington, and Texas have gross receipts taxes that companies may become subject to when employing a remote employee in these jurisdictions. Gross receipts taxes can be particularly burdensome for companies with high gross receipts but low gross profits and/or net operating losses because these taxes directly impact cash flow. Similarly, franchise or net worth taxes are computed using a company’s gross or net assets, depending on the jurisdiction, and can be material for companies that have large infusions of cash from investors or companies that have a low debt-to-asset ratio. Approximately 15 states, including Delaware, Illinois, and Massachusetts, have some form of franchise or net worth tax that may be applicable to companies that give rise to the definition of doing business in applicable jurisdictions.

Various jurisdictions also impose minimum tax requirements on companies that are registered or have nexus in the state. While annual minimum taxes can range anywhere from $50 in New Mexico to $800 in California or up to $4,500 in New York based on annual activity, they can multiply annually and be subject to failure to file and/or penalties plus interest that can quickly add up to material liabilities if not complied with and managed appropriately.

Other Considerations

Oftentimes, real estate companies are organized as tiered partnerships that may be unitary, having centralized ownership, operations, and management or business functions. Business activity such as payroll and rent expense, the cost of property, and gross receipts are data used in the computation of apportionment, a method of allocating income and loss to a particular tax jurisdiction. In these structures the apportionment factors of the lower tier entities may flow through to the upper tier entities leading to state filing requirements even when a standalone legal entity may not have state activity.

Additionally, another important consideration of having multistate employees and business activity is the consideration required to be given to the statutory and regulatory business registration and licensing requirements on a jurisdiction-by-jurisdiction basis. Oftentimes these requirements can differ from state to state and even on a city and county level, depending on the nature of the business and the level of activity being performed in a jurisdiction.

With proper planning, a company can tackle state and local taxation and the legal requirements that states impose upon companies doing business in their jurisdiction in order to mitigate risk and avoid unpleasant and costly surprises that impact cash flow and potentially a company’s financial position. Management should always consult with legal advisors and tax advisors with regard to the legal and compliance requirements of operating a business across state lines.

Rebecca Stidham, Senior Manager – Tax Services at OUM & Co. LLP, has significant experience with the requirements of jurisdictions in all 50 states applicable to state and local tax liabilities. She has more than 11 years of corporate and pass-through tax compliance experience as a state and local tax practitioner in public accounting, with an emphasis on direct and indirect compliance for companies operating in the technology, SaaS, rental real estate, professional services and venture capital industries.