As November 2020 comes to a close and the promise of a vaccine is beginning to become a reality, the attention of the business community — which for almost nine months now has been trained on guiding the economy through the COVID recession in one piece — is now turning to what life after the pandemic will look like.
Leaders of professional services firms are waking up to the realization that unlike the pandemic, which while indisputably tragic, is ultimately temporary, widespread remote working is here to stay. Over the past year, many employees have discovered that they prefer working from home all or part of the time over going into a shared office. Businesses, too, are seeing the advantages in the form of, often, increased productivity and the possibility of pulling back from expensive commercial office rents. And with businesses like Google and Microsoft extending — or in the latter case, making permanent — their work from home options, remote working is likely to become a common perk for firms competing for talent.
The upshot is, remote working is not just a COVID-19 issue. It is a reality that going to be with us for the foreseeable future — and likely permanently. That is why it is so important that leaders of professional services firms understand the tax implications of hiring and maintaining a remote workforce. Many states have regulations that that could significantly affect a business’s tax liability, and in turn, influence decisions about who and where these firms decide to implement their remote workforces.
In the meantime, however, the immediate goal for firm leaders is to ensure their businesses are paying all the taxes they owe to avoid painful audits and fines down the line. To that end, we have identified our top four tips for professional services firms with remote workers to ensure they are meeting all their tax requirements in all the jurisdiction whose taxation they may be subject to.
1. Use automated tools to track your employees’ work locations.
Before you can do any analysis of potential tax liabilities arising from remote workers, you need to have organized, up-to-date data detailing where each member of your staff is completing their work from. For very small organizations, it may be easy enough to keep track of this information in a spreadsheet. But for businesses with more than, say, 10 employees, tracking and maintaining this information manually could quickly become excessively time-consuming. Look for a solution that makes it easy for employees or your human resources team to update — and for leaders to interpret at-a-glance — key information such as where an employee is working from currently, how long they have been there, and where they were working before the pandemic began. Only once armed with this information can you start to determine where your business might owe new taxes and where you need to investigate further.
2. Understand payroll and withholding tax requirements in all states where your business has remote workers.
Most of the 50 states, with the notable exceptions of Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming, impose taxes on employee wages. These taxes come in the form of payroll taxes (i.e., taxes paid by the employee) and withholding taxes (i.e., taxes paid by the employer), both of which the employer is required to calculate, then withhold the employee’s portion, and finally remit both their and the employee’s portion to the state government. The calculation and withholding part is actually relatively straightforward, though; it is determining whether your business has income tax requirements in a given state that can get complicated fast.
The main criterion for determining whether your business has any payroll tax requirements in a given state where you have or had employees working from home this year is for what period of time they work(ed) there remotely. In most states, any employee working out of a home office in that state for more than a few weeks may, at least under usual (non-pandemic) circumstances, trigger payroll tax requirements.
Complicating all this is the fact that some states, like New York and New Jersey, have worked out reciprocal agreements such that a company in one state may have employees in the other without having to collect and remit payroll taxes in that state. Additionally, some states have made special pandemic exceptions, relaxing the usual requirements for a certain period of time (though some of these exception periods have lapsed already).
But where it gets really complicated is when it is determined that payroll taxes are required in multiple states in which a single employee worked throughout this year. In these circumstances, businesses will need to withhold and remit payroll taxes in more than one state for the wages of just one employee. This can be particularly problematic if that exposes the businesses to a new state tax regime where the business did not previously have any customers or business activity, as discussed in the following section. As this discussion hopefully makes clear, though, having an accountant experienced in state and local taxation (SALT) matters on your team will be invaluable going forward for businesses that plan to maintain remote working arrangements.
3. Determine whether your business owes income tax in states where you have workers.
The other unexpected hiccup that can arise when your business has employees in other states is that the presence of employees in some states can actually trigger business income tax filing requirements in some situations. Readers may recall that in order for a business to be subjected to a given state’s tax regime, they must exhibit a certain threshold of economic activity or connection to the state such that they can be considered to have a “nexus” (i.e., physical presence), or else an “economic nexus” in that state. Typically, there are several ways a business can trigger nexus thresholds such that they are subject a state’s income tax regime. Having a business location in the state is one way; exceeding a certain sales amount or number of transactions in the state may be another, depending on the state.
But another surprising way businesses may trigger a nexus in a state is to have employees performing services in that state. Remote workers could very well fall under that latter category and cause your business to owe state income tax. This in turn could require complex apportionment calculations to ensure that the taxes paid to each state reflects the right percentage of your business’s profits that each is entitled to.
Of course, all this is highly variable on a state to state basis, so make sure whoever prepares your business’s taxes has a strong understanding of the income tax nexus rules in each of the states you have employees working remotely.
4. Remember that some cities have their own taxes, too.
States are not the only jurisdictions that want their cut that businesses have to worry about. Certain cities — San Francisco and Denver are two major examples — have payroll taxes of their own. Thankfully, the algorithm for determining whether and how much a business owes is more or less the same. First, determine if you have any employees working in any of these cities with these special taxes. Then, determine whether that employee’s presence makes your business subject to withholding or payroll tax requirements. In San Francisco, for instance, any employee engaged in business within the city limits whose annual expense exceeds $320,000 is subject to a 0.38% tax on their payroll expense (defined as the sum of any salary, wages, bonuses, commissions, issuance of property, or compensation of services to owners of pass-through entities).i
In any case, do not assume that the taxes you paid in previous years, before COVID, are a reliable indicator of what you will pay this year. In fact, there is a bit of a silver lining with regard to city payroll taxes. Given that it is far more common for employees to commute into cities that have these kinds of taxes than to commute out of them, it is likely that most businesses located in these cities and that are subject to these kinds of taxes will actually catch a bit of a break here.
Accounting, tax, audit services and more from a firm who takes our work as seriously as you do.
Whether you are going through an acquisition, strategic planning before Tax Day, or looking to use a third-party back office, BPM has a full suite of services designed to assist your professional service firm’s needs. Professional services providers, including but not limited to attorneys, architects, consultants, staffing agencies, medical providers and advertising agencies, run into many of the same challenges and share their own set of financial complexities, and it takes a team with specialized expertise in this distinct space to know how to solve them. BPM’s dedicated Professional Services team focuses our time on learning the best tactics to proactively tackle these tax, assurance and accounting tasks for our clients. To learn more about how BPM can help your business succeed, contact Doug Schultz, partner, at DSchultz@bpmcpa.com.