Unexpected Tax Consequences of Remote Workers
Date: May 10, 2021
Following the U.S. Supreme Court’s landmark decision in South Dakota vs. Wayfair, Inc. in 2018, an employer may be subject to a variety of taxes due to its economic nexus with a state. In the tax context, “nexus” means that there are sufficient contacts between an organization and a state for the state to exercise its taxing authority over that organization. Prior to Wayfair, the bar was set fairly high for an association or other nonprofit organization to have nexus with a state. A physical presence was required such as an office or the use of a warehouse in that state to store goods. With the increase of online shopping over the years, states realized that they were losing out on sales tax revenue from internet sales as well as income tax revenue from the sellers. In Wayfair, the Supreme Court recognized that an entity may have an economic nexus with a state that is sufficient to enable the state to exercise its taxing authority over that entity. In the wake of Wayfair, states rushed to adopt new laws expanding their taxing authority over those with economic nexus in their state. While some states established a threshold of sales that must occur before the state would require sales tax collection, others states chose not to adopt any minimum threshold.
What does this mean for your organization? Having a single employee working from home in a state may be sufficient nexus to allow that state to impose its taxing authority on the organization. Having a tax exempt status in one state does not mean that the organization is automatically exempt from taxation in other states. In most states (with a few statutory automatic exceptions for churches and other types of nonprofits such as scouts or PTAs), once an organization has its determination letter from the Internal Revenue Service confirming that the organization is exempt from federal income tax, the organization must also apply for exemption from state and local income taxes. (Note that the name of the tax might vary with some state or local governments having franchise taxes or business license taxes.) In order to avoid creating a tax obligation, an exempt organization should apply for tax exemption with all applicable taxing jurisdictions.
And then there is the sales and use tax. A sales and use tax is imposed in 45 states plus the District of Columbia. (States without a sales tax are AK, DE, NH, MT and OR.) Exemptions for sales and use tax are often available for certain types of exempt organizations such as those that are exempt under IRC section 501(c)(3). But in the majority of cases, the organization must submit an application in order to receive the exemption from paying sales and use tax. A separate application is often required if the organization qualifies for an exemption from collecting sales tax on those goods and services that it sells which are subject to the tax. In the absence of an exemption, an association that sells publications or other merchandise is required to collect sales tax on its sales unless the association is located in a state without a sales tax.
[Sidebar: Sales and use taxes are two sides of the same coin. A sales tax is imposed by State A for purchases made in State A. A use tax is imposed by State A on purchases made in State B but brought into State A if the purchaser did not pay sales tax in State B. While some states try to collect use tax from their residents when they file their annual income tax returns, the focus is usually on those companies engaged in interstate commerce who are not collecting tax.]
An organization that thought it had a handle on its income and sales and use tax exemptions or payment and collection responsibilities might find that it has new tax obligations due to its employees working from home. For example, an association with its sole office in Washington, DC, might find that its employees are now working from home in Maryland, Virginia or West Virginia. Or they might have traveled to another state to take care of aging parents or a sick friend or relative. If the employees work remotely for only a short period of time, they are not likely to create nexus in that state. But if they are there indefinitely or decide to continue to work remotely for the foreseeable future, they might have created a tax nightmare for their employer.
The information contained here is not intended to provide legal advice or opinion and should not be acted upon without consulting an attorney. Counsel should not be selected based on advertising materials, and we recommend that you conduct further investigation when seeking legal representation.