More people are working remotely these days and that trend seems unlikely to change even after the pandemic is over. Remote work can be convenient. However, it raises the risk of double taxation if employees work in different states from their employers. Here is what you need to know — and what you can do — to prevent a second tax bite.
Domicile versus residence
Generally, states have the power to tax the income, wherever earned, of their residents or those domiciled within their borders. Your domicile is your “true, fixed, permanent home” or the “principal establishment to which you intend to return whenever absent.” In contrast, your residence is the place where you maintain a “permanent place of abode” and spend the majority of your time.
Domicile is a state of mind, whereas residence is based on physical location. So it is possible to have your domicile in one state and your residence in another. Suppose you have lived and worked in Illinois for years. However, during the pandemic, your employer allowed offsite work and you have chosen to work primarily from your vacation home in Wyoming. Illinois continues to be your domicile. But because you are spending most of your time in Wyoming, that state treats you as a resident. The result: Both states impose taxes on the same income.
Fortunately, many states provide relief from this sort of double taxation. Some states have reciprocity arrangements with neighboring states under which they agree not to tax each other’s residents. And many states offer credits for taxes paid to another state. But these credits may not fully offset the cost of double taxation. Suppose State A has a high rate of income tax and State B has a low rate of income tax. Even if State B provides a credit for taxes paid to State A, it will only be partial and your tax bill will be substantially higher than it would have been if only State B’s tax were applicable.
Here is a possible solution: If you have been living in and working remotely from another state and will likely continue to do so, consider establishing your domicile there. Changing your domicile involves taking steps that demonstrate your intent to make the new state your “true, fixed, permanent home.” For example, in State B, you might want to:
- Obtain a driver’s license;
- Register your car;
- Register to vote;
- Open bank accounts;
- Join a local gym;
- Join local social and professional groups; and
- Become a member of a local religious congregation.
If you can establish that State B is both your residence and your domicile, you may be able to avoid taxation by State A.
Beware “convenience of the employer”
Employees who work remotely for an employer in another state typically are not subject to that state’s income tax so long as they are not residents of or domiciled in the employer’s state. But that may not be the case in the handful of states that have adopted so-called “convenience of the employer” rules.
Let us say that State A has such a rule. Even if you change both your residence and domicile to State B, you will be subject to State A’s income tax if you work in State B for your convenience rather than your employer’s. In other words, if you live and work in State B for personal reasons, and not because it is a requirement of the job, then State A can tax your income.
The following states currently have convenience of the employee rules: Arkansas, Delaware, Nebraska, New York and Pennsylvania.
Know the rules
State income tax rules can be complex and often vary dramatically from state to state. If you are working remotely for an employer in another state, familiarize yourself with the rules in each state. Then, take any available steps to avoid double taxation.
Related Read: Working Remotely From “Out of State” Can Be Taxing
For more information, contact Colin O’ Neill at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Wealth Management Services.