By – Kristin Popp-Inegbedion
As employers around the world passed their one-year anniversary of working from home, many tech companies announced their employees will not have to return to offices and instead can work remotely from anywhere. Even Ford announced in March that around 30,000 employees will have the option to work from home.
Although this sounds great for the employees, and may save on rent for the employer, there are tax related issues employers will have to keep in mind.
Many employees in high cost-of-living states, such as California, have taken advantage of the remote working environment by working from states where the cost-of-living is lower. While this is a clever idea it subjects the employers to potential payroll tax withholding and tax payment requirements in these states. Since all states have different requirements with different thresholds, companies should evaluate possible new tax obligations if they have employees working from states all over the US.
In the remote working environment, employers need to keep track of their employees’ location in order to fulfill their withholding requirements. Employers also need to understand if having an employee in a certain state could lead to nexus for state taxes.
Which States Can Tax Compensation?
The question of which state has the rights to tax compensation and to impose state taxes in a remote working environment has already made it up to the US Supreme Court. The state of New Hampshire filed a suit against the state of Massachusetts because Massachusetts has continued to impose tax on employees who previously commuted from New Hampshire to Massachusetts even though these employees are now working remotely from New Hampshire due to COVID. New York has a similar situation for workers who previously commuted from New Jersey and Connecticut.
Depending on how this case is decided, it could lead to a whole new definition of “tax home” and “where” work is done.
Implications Beyond the US
The consequences for employees working remotely from a foreign country can be even more significant. Companies act globally, countries do not. What that means is every country has their own tax laws and withholding requirements. Employees who work remotely from a different country may discover unintended tax for them, as well for their employees.
For example, if an employee decides to work in Spain for the rest of 2021, they may become a tax resident of Spain and may be subject to Spanish tax. As a US citizen, they also would be subject to US taxes on their worldwide income with the possibility of excluding a portion of the income or taking a foreign tax credit. The employee may also be subject to foreign social security and other payroll taxes.
More significantly, their employer may now have a responsibility to withhold Spanish tax from their compensation. If an entity does not have a foreign subsidiary in the country in question this is almost impossible to do without incurring a lot of administrative costs for a PEO.
Furthermore, the employee working abroad might be creating a permanent establishment in the foreign country by working there for an infinite period of time. A permanent establishment would lead to a portion of the business income being taxable in the foreign country. This is typically the case if the employee creates revenue or if the employee has the authority to conclude contracts.
Every country has different criteria for what constitutes a permanent establishment and therefore it is important to look at the different countries the employees might be working in, their tax regimes and permanent establishment criteria.
Employers based outside of the US face the same considerations. For example, a Canadian employer may find they have employees working remotely in the US for an extended period of time. In this case, there would not only be federal consequences but also state tax issues would have to be taken into consideration.
As employers are debating their post-COVID work environment, offering the flexibility of remote work has strong appeal for a variety of reasons. The tax implications of these decisions need to be factored into analysis alongside employee retention motives. Employers may want to define parameters around the scope of the remote work environment to reduce the potential for tax surprises down the road.
About the Author
Kristin Popp-Inegbedion is a member of Frazier & Deeter’s International Tax Practice, where she specializes in Global Mobility. Originally from Germany, she is an attorney as well as a certified public accountant.