NY Convenience of the Employer Rule Is an Audit Risk

New York’s convenience of the employer rule for remote workers is increasingly the subject of state audits as remote work grows, two consultants said May 14.

The state’s rule “really kicked off in the late ‘90s,” said John Montgomery, a partner at KPMG. Employees receiving “gigantic” stock options who lived in other states and worked in New York were only allocating 80% of the option’s exercise value to New York on nonresident returns because they worked from home one day a week, he said.

Connecticut and New Jersey both have what Dylan McLaughlin, a senior manager at KPMG, called a “mirror convenience of the employer rule” because it only applies when the employee’s state of residence also has a rule.

Under the convenience of the employer rule, employees still have New York tax withheld if they are working remotely for a New York employer, but withholding for the resident state may also be required if it has higher tax rates, McLaughlin said. Like other multistate employees, New York tax is withheld first and then any higher portion of the resident state’s tax is withheld, he said.

Additionally, an employee may be a New York employee for withholding purposes but may be covered by unemployment insurance or paid family leave in their state of residence, Montgomery said.

The exception to the rule requires that an employee’s home office be a bona fide employer office based on meeting either the primary factor, that the home office contains or is near specialized facilities, or meeting four secondary factors and three other factors, Montgomery said.

Secondary factors include that the employee is required to have a home office. “Most companies don’t meet this factor,” Montgomery said, but noted that some employers are adding a requirement to have a home office in their employment agreements.

Other secondary factors include that the home office has a bona fide business purpose, the employee performs core duties from home, the employee does not have a designated office space, or the employee regularly meets with clients at home, Montgomery said.

Montgomery noted that New York’s guidance on the test is from 2006 and does not address virtual meetings with clients, for example, which he believed would suffice. “New York just hasn’t updated this or published anything that says that, but we feel comfortable that having those interactions at home would get you there,” he said.

“Three of these tend to be easy, to pick up a fourth one could be difficult,” Montgomery said of the secondary factors. “If I have a client that really wants to do this, I love to have five” so they still have a chance if one does not stand up, he said.

The 10 other factors include that an employee uses an area of their home strictly for business, which McLaughlin said employers are also increasingly adding to employment agreements. They also include that business records are stored at the home office including on a computer, the home office is covered by the employer’s business insurance policy, and that the employee claims a deduction for home office expenses, McLaughlin said.

Montgomery and McLaughlin spoke at PayrollOrg’s 44th Payroll Congress in Nashville, Tennessee.

Audits Increasing

“I would say in the last year, I’m doing about 10 times the audits we used to. They’re auditing everyone,” Montgomery said.

Auditors want the employer to show that an employee is not telecommuting to New York and also look at the locations of any employees that have filed New York resident or nonresident tax returns in the previous five years, Montgomery said.

Stock options or any other equity payment with a vesting period can also represent a connection to New York if an employee worked there any time during the vesting period, Montgomery said.

Among the penalties for noncompliance is the late payment penalty, which is 0.5% of the unpaid tax per month up to a maximum of 25%, McLaughlin said. The penalty for willful failure to withhold leaves the employer responsible for the tax owed, penalties, and interest, he said. Not correctly classifying a remote worker as a remote worker, resulting in not withholding New York tax and not reporting wages to New York, would count as a willful failure, McLaughlin said.

“If you don’t withhold on your employee and you should have under a telecommuter rule, on the audit you’re going to pay the taxes,” Montgomery said. “You can’t go back to the employee to get the money.”

The state formerly focused on the financial services, entertainment or communication, pharmaceutical, and retail industries for withholding audits, but no longer does so, Montgomery said. A potential audit trigger is if an employee files a New York nonresident return when the employer is not registered for withholding, he said.