How the pandemic is complicating taxes for millions of Americans
Even the certainty of paying taxes every year isn't immune from the economy-rattling impact of the coronavirus. That could be the rude surprise awaiting millions of Americans who are working from home in one city or state rather than from their employer's offices in another state.
"Many Americans will soon find out that they have tax liability in a state where they didn't expect," said Jared Walczak, a fellow at the Tax Foundation, estimating that tens of millions of people could be affected. "It has the potential to discourage Americans from working from home in the future."
Generally, Americans pay state income tax based on where they work, not where they live. For many who live and work in the same state, that's a non-issue. But for workers whose pre-pandemic commute took them across a state line, the fact that they spent most of 2020 working from home could mean they owe income taxes in a different state than where they have filed their taxes in the past.
Potential taxpayer penalties
Many workers appear unaware that working from home could change where they send checks next April 15. An October poll of employees by the American Institute of Certified Public Accountants found that 71% didn't know that working from home could impact their state income taxes.
Worse, the fix might not be as easy as simply filing their returns in another state come Tax Day. Many states require companies to withhold income taxes from employee paychecks throughout the year. Both employers and employees have an obligation to direct taxes to the state in which they worked.
Yet despite the huge number of people who have shifted to working from home, it appears most companies have continued to withhold taxes for the states where employees have always paid taxes. Those tax dollars will have to be redirected — and some workers could face penalties for not withholding in the correct state.
Complicating matters is that while some states have issued guidance on whether they will collect income taxes from residents working from home, others haven't.
"Some states have put forth temporary guidance, " said Jamie Yesnowitz, an expert on state and local taxes at accounting and consulting firm Grant Thornton. "But the lack of uniformity is going to cause challenges for a reporting perspective."
Pitting state against state
The issue is also heating up a long-simmering fight over the billions of dollars that some states collect from commuters each year. In the past decade, more than a handful of states have passed what are called "tax convenience" laws, which allow them to tax workers even if companies permit or encourage employees to work outside the state. New York, which collects some $7 billion per year in income taxes from non-residents, was the first to pass one of these laws, and others have followed.
New York has traditionally shown little mercy on the issue. Indeed, Governor Andrew Cuomo said earlier this year the state would continue to impose income taxes on out-of-state health care workers who commuted to New York during the worst of the pandemic there.
The issue of where workers live and where they pay taxes is also causing friction between neighboring states. New Hampshire sued Massachusetts in October over its tax convenience law. Massachusetts passed its measure earlier this year, after it was clear that it could lose out on tax revenue from commuters who were no longer commuting. New Hampshire doesn't impose an income tax, so the law could increase taxes for residents of the state who worked from home this year and planned to file in their home state.
"Massachusetts cannot balance its budget on the backs of our citizens, punish our workers for making the decision to work from home and keep themselves and their families and those around them safe," New Hampshire Governor Chris Sununu said in a statement at the time the suit was filed.
Beware double-taxation
Tax convenience laws could also cause a mess for individual taxpayers as well as policy makers. If states decide to impose income taxes on residents who worked from home, those individuals may be forced to pay taxes not just in their home state, but also in the state where they are employed.
"Double taxation is potentially a problem in a number of situations," said Grant Thornton's Yesnowitz. "In many instances, you can't get away from tax obligations by just working somewhere else."
Many experts thought Congress was likely to step in and fix the overlapping tax liabilities created by massive numbers of individuals working from home during the pandemic. But legislators have been reluctant to pass a law, even a temporary one, that could encroach on states' tax authority. Notably, no such remedy is part of the $900 billion economic relief bill that lawmakers are now debating in Washington, D.C.
Some tax policy advocates are using the issue to push for a long-term fix. They say that taxing Americans where they work, rather than where they live, makes the tax code more complicated; discourages companies from instituting more flexible work arrangements; and stifles the kind of technological innovation making it possible for companies to have a more mobile workforce.
"I hope there would be a temporary fix, but a more permanent one would be ideal," said Eileen Sherr, state tax policy expert at the American Institute of Certified Public Accountants.
A problem that's here to stay?
As some states fight over tax dollars, others have decided not to rock the boat during the pandemic. New Jersey is one of 15 states that have said it won't require residents to pay taxes to the state just because they worked from home in 2020. That eliminates the fear of of double taxation and other filing headaches for the roughly 400,000 New Jersey residents who live in the state but whose jobs are located in New York.
Connecticut, on the other hand, has not said what it plans to do about the issue.
If the trend toward telecommuting continues after the pandemic, as many believe it will, states and cities like New York that had traditionally drawn workers across the border may face pressure to stop taxing out-of-state residents — a major hit to local government revenue. Already, New Jersey lawmakers have been pushing for the state to re-examine its tax agreements with New York.
Said Walczak of the Tax Foundation, "This is not a short-term problem because remote work is not going away."