Wage allocation is an issue that often leads to audits in many states. New York is a prime example of a state renowned for its tax treatment of non-residents, because in some situations, non-residents also have to pay New York taxes under state rules. While this process is generally well-established and not problematic in most states, the onset of COVID-19 and the shift to telecommuting has raised new questions.
This week, the Minnesota Department of Revenue released guidance regarding employees who normally work in Minnesota and live in another state and are now working from home due to COVID. The guidance states that wages should be allocated to the state where work was physically performed. Given that, taxpayers/employees may need to allocate their wages based on the number of days worked in their home state. Further, the guidance also instructs taxpayers/employees to request from their employer a corrected W-2, (W-2c), allocating income to the state in which work was done. (See (How to handle incorrect wage allocation on 2020 Forms W-2, Minn. Dept. Rev., 02/17/2021.)
The state of New Jersey also issued guidance on allocation during the pandemic, via updated FAQs on their Division of Taxation site. On the topic of telecommuting during the pandemic, the state provided: “New Jersey sourcing rules dictate that income is sourced based on where the service or employment is performed based on a day’s method of allocation. However, during the temporary period of the COVID-19 pandemic, wage income will continue to be sourced as determined by the employer in accordance with the employer’s jurisdiction.”
The Illinois Department of Revenue issued an informational bulletin that said that “out-of-state employers who normally would not be required to withhold Illinois income tax from employees who are Illinois residents may now be subject to Illinois withholding requirements. Employee compensation is subject to Illinois Income Tax Withholding when the employee has performed normal work duties in Illinois for more than 30 working days.” See: Illinois Dept. of Rev. Info. Bulletin No. FY 2020-29, (May 1, 2020).
States with reciprocity agreements eliminate this issue, as there is agreement not to tax the residents of the other state. (Reciprocity agreements allow residents of one state to work in another state without having taxes from that state withheld from their pay). Given that most states have no reciprocal agreements in place, the allocation problem will remain for most employers.
Employers should check guidance in the states in which their employees are working to ensure you stay current on the latest developments. As the pandemic lingers, more states have added information regarding to this topic to their revenue/taxation websites, and these questions will undoubtedly arise with more frequency as tax season progresses and clarification is sought.
For more of an in-depth look at managing tax localities, read Understanding Tax Withholding for Remote Employees.