According to the Telework Research Network, just over 2 million or 2% of the US employee workforce considers home their primary place of work.  When you add in those who work from home at least one day per week, the number grows to an estimate of between 20 and 30 million.

Many companies have cut millions in costs by shifting the burden of office space to the employee.   The focus of this post is on an emerging trend of the taxation of those who telecommute from their home which is in a different state than their employer. This is important to you, the business owner, because of the related payroll tax, unemployment tax and workers’ compensation issues.

General Rule

Based on the general rule of paying taxes where you work, 36 of the 41 states that have an income tax impose the tax based on an apportionment of time and the location where the employee performs their services.  For our teleworker described above, this would be his home state.

Alternate Approach Gaining Popularity?

A minority of states (currently Delaware, Nebraska, New Jersey, New York and Pennsylvania) takes a different approach and looks to the home state of the employer for income taxation, known as “the convenience of the employer test”.

A recent case under this theory shows that a portion of the same earnings can be subject to double taxation.  A professor living in Connecticut and teaching in New York 3 days a week spent the other two days in his home office.  Even though he allocated a portion of his earnings to the two states based on the time spent in each location, a New York court found that the professor owed New York tax on all of his income under this theory.  And since Connecticut only provides for a tax credit based on work OUTSIDE the state, he ended up paying double on the income earned for his two days a week in his home office.

Despite our professor’s appeal to a higher court, he lost his argument that the convenience of the employer test was a violation of the Constitution’s limit on the powers of the state.  Two other New York cases came to similar conclusions that 100% of the earnings were taxable to New York; however, there was no double taxation as the workers lived in Tennessee and Florida, two states without an income tax.

This is an issue to watch, especially as deficit ridden states look to raise revenue wherever possible. In the meantime, New York has issued guidance to reduce or eliminate state tax liability of out of state workers based on facts and circumstances.

Talk to your favorite CPA about your situation, or contact us for more information on this emerging issue.  The mutual benefits of telecommuting for both the employer and employee are significant.  We don’t see this issue going away.