Tax Connections Newsletter – Winter 2023
Beware of Tax Surprises if You Work Remotely
The COVID-19 pandemic forced many employees to participate in a global experiment on the pros and cons of remote work. As a result, it is here to stay for many businesses. A remote workforce offers many benefits, for employer and employees alike. But it may also lead to some tax surprises, especially if workers cross state lines.
Employees: How to avoid double taxation
It was not unusual, during the early days of the pandemic, for employees to work remotely from another state. Perhaps they wanted to take advantage of a vacation home during lockdown or simply wanted to get out of the city for a while. For some businesses, however, remote work has become a permanent arrangement, allowing employees to live and work further away from the brick-and-mortar office.
If you live in one state and work remotely for an employer in another state, familiarize yourself with the tax laws in both states and determine how they may affect you. For example, you may need to file income tax returns in both states, which may result in increased — or even double — taxation.
Here is the problem: States generally have the power to tax the income of people who are domiciled there, as well as people who reside there. Domicile is a state of mind, and is often based on a person’s intent to make a location his or her “true, fixed permanent home.” Residency is based on physical presence in a state for a certain amount of time (typically, 183 days per year).
It is possible to be domiciled in one state and a resident of another. For example, Dan has a home in State A, where his job is located, and a vacation home in State B. His employer allows employees to work remotely, so Dan now spends more than 200 days per year living and working in State B. State A considers Dan to be domiciled there, but State B views him as a resident, so he is subject to taxes in both states on the same income. He may avoid double taxation if one or both states provide credits for tax paid to other states. But his tax bill may still increase if, for example, State B’s income tax rate is significantly higher than State A’s rate.
One way for employees to avoid double taxation is to ensure that they are both residents and domiciliaries of the state from which they are working remotely. Going back to the example, if Dan sells his home in State A and takes other steps to cut ties with State A and establish roots in State B, he may avoid taxation by State A. However, this may not work if State A is one of the handful of states that have enacted “convenience of the employer” laws. Under these laws, a state can tax an out-of-state employee’s income from a source within the state, if the employee works remotely for his or her own convenience, not the employer’s. In other words, State A can impose its income tax on Dan by demonstrating that he is working from State B for personal reasons rather than because it is a job requirement.
Related Read: Working Remotely? Watch Out for Double Taxation
Employers: Why multistate tax issues matter
From an employer’s perspective, allowing employees to work remotely may create obligations to withhold and remit income and payroll taxes in several states. Plus, having employees in other states may be sufficient to establish nexus with those states, potentially triggering liability for their income, franchise, gross receipts, or sales and use tax. In addition to the expense of tax reporting in multiple states, this may increase an employer’s overall tax liability.
Typically, states determine the portion of a business’ income subject to their taxes based on an apportionment formula tied to the percentage of the business’ sales, property and payroll attributable to that state. Most states’ formulas consider either all three factors or a single sales factor. Whether apportionment increases or decreases a business’ tax liability depends on whether its income is apportioned to a state with higher or lower tax rates than its home state.
Exercise remote control
If you are a remote worker or own a business that employs remote workers, be sure you understand the tax implications. In some cases, you may be able to take steps to minimize multistate tax obligations. But even if you cannot, it is important to know what to expect.
Related Read: Working Remotely From “Out of State” Can Be Taxing
Sidebar: Can remote workers deduct their business expenses?
Generally speaking, employees cannot deduct unreimbursed job-related expenses under current tax law. Prior to the Tax Cuts and Jobs Act (TCJA), employees could claim certain costs as miscellaneous itemized deductions, which are deductible to the extent they exceed 2% of adjusted gross income. But the TCJA eliminated those deductions for 2018 through 2025.
Remote workers generally are not eligible for the home office deduction either. That deduction is generally limited to self-employed business owners. Pre-TCJA, employees could claim the deduction if, among other things, they worked at home “for the convenience of the employer.” It may be difficult for remote workers to demonstrate that they are working at home for the employer’s convenience. But in any event, the TCJA also eliminated that provision for 2018 through 2025.
The most tax-efficient option is for the employer to reimburse remote workers for their business expenses according to an “accountable plan” that requires employees to substantiate their expenses and meets certain other requirements. Properly reimbursed expenses are deductible by the employer and excludable from the employee’s income.
Charitable deductions: Dot the i’s and cross the t’s
Do not underestimate the importance of the substantiation requirements for deductions of charitable gifts. In a recent U.S. Tax Court case, a taxpayer lost nearly $500,000 in deductions because she failed to obtain a satisfactory contemporaneous written acknowledgement (CWA) of her gift. The taxpayer donated 120 items from her collection of Native American artifacts and jewelry to a local museum. On the day the donation was made, the taxpayer and the museum executed a “deed of gift” describing the donated items and the terms of the gift.
Donations greater than $250 require a CWA that includes the amount of cash and a description of any property other than 1) the cash contributed; 2) whether the recipient provided goods or services in consideration for any such property; and 3) a description and good faith estimate of the value of any goods or services. In this case, because the deed did not specify whether the museum provided the taxpayer with any goods or services, the deductions were denied.
Related Read: Substantiating Charitable Gifts: Do You Know the Rules?
When turning down an inheritance makes sense
Turning down “free money” may seem counterintuitive, but in some cases, it makes sense to reject (or “disclaim”) an inheritance. It could reduce your family’s overall tax liability to pass to someone else property that generates taxable income or would trigger gift or estate tax. For example, let us say that you inherit an IRA from one of your parents and that your child is the contingent beneficiary. Given your high tax bracket, distributions from the IRA will generate significant income taxes. If you were to disclaim the inheritance, however, it would pass to your child who, presumably, is in a lower tax bracket.
Is student loan forgiveness taxable?
If you or a family member was fortunate enough to have a student loan forgiven, will the amount forgiven be taxable? Generally speaking, forgiven debt constitutes taxable income. However, forgiven student debt is currently exempt from federal tax through 2025. In addition, most states exempt student debt relief from their income tax, but there are some exceptions.
According to a recent analysis by the Tax Foundation, forgiven student debt may be taxable in Arkansas, California, Indiana, Minnesota, Mississippi, North Carolina and Wisconsin. However, state rules on this issue are in flux, so check on recent developments in your state.
For more information, contact Rob Swenson at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Tax Services.
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