United States: Tax Traps and Opportunities From Employers Requiring Employees to Work From Home

Following the advice from the Centers for Disease Control and Prevention, employers are increasingly encouraging or requiring that employees work from home. This is an important strategy for combating the coronavirus (COVID-19) and slowing its spread. It also creates both potential traps for the unwary and opportunities for a business located in one state with employees who reside in another state. We focus on Washington and Oregon because those are the states we know best but the concepts discussed here should apply whenever an employee resides in one state and works for an employer in another state.

Potential Trap for Washington Employer With Employees who Live in Oregon

Washington-based businesses often have employees who live in Oregon and make the daily commute over the Columbia River. As one of the few states without a personal income tax, the employees have no Washington income tax liability, which also means that Washington employers have no Washington income tax withholding obligation. As Oregon residents, the employees still owe Oregon personal income tax. However, because the Washington employer has no Oregon income tax withholding obligation, the employee is responsible for paying their Oregon tax directly. (Many Washington employers undertake Oregon withholding as a courtesy to their Oregon resident employees.) Having an Oregon resident employee work from home may change the employer’s withholding obligations.

Out-of-state businesses that are considering having one or more employees based in Oregon need to consider the withholding tax consequences of such decisions. Having employees in Oregon trips many regulatory wires, including registering as a foreign business, needing to appoint a registered agent for service of legal papers, and subjecting the non-Oregon business to Oregon income tax withholding obligations. The applicable Oregon administrative rule provides:

Withholding is required of employers situated outside the state upon wages, commissions, or other emoluments paid to an employee or agent for services performed within the state, even though the employee or agent may be a nonresident and their Oregon employment may be of short duration.

Historically, we understand that the compliance rate for unknown or infrequent work in Oregon likely is quite low except where the dollars are large (e.g., sports teams and rock stars who only appear infrequently in Oregon but who make a good deal of money when they do). Compliance with this withholding requirement is much harder to ignore when the employer requires or expects that its Oregon resident employees work from their homes in response to the coronavirus.

Because this issue arises in the context of a global pandemic declared a national emergency, there is a possibility that the Oregon Department of Revenue might not take aggressive enforcement actions. Further, income tax withholding primarily serves as a backstop to ensure that Oregon receives the income tax owed by the employee. So if the employee pays the Oregon tax owed, the employer’s liability for the tax is generally eliminated (but penalties may still apply). Still, the employee working from home in March and April 2020 may not be able to pay the Oregon income tax due in April 2021 (possibly because of costs associated with the coronavirus). In this future time, when people are not as focused on or concerned with this coronavirus crisis, the Oregon Department of Revenue (“ODOR”) will have the choice between collecting from the sympathetic Oregon resident or the out-of-state business, and it is easy to imagine whom ODOR will chase. Indeed, ODOR, like the revenue collection agencies of all jurisdictions, generally prefers to pursue an employer for failure to withhold because employers are usually fewer in number and easier targets than the employees who may not have the funds to pay the tax.

In addition, the employee working from home in Oregon could subject the Washington employer to tax nexus for purposes of Oregon’s income tax and new corporate activity tax (“CAT”). Of course, Oregon’s “economic nexus” rules (i.e., the ability to have taxable nexus without a physical presence) have greatly reduced these concerns in recent years because many non-Oregon businesses with no physical presence in Oregon are already subject to Oregon’s income tax and CAT. Stated differently, Oregon resident employees working from their home could create nexus for non-Oregon businesses that do not otherwise satisfy the amorphous standard of having a “significant economic presence” in Oregon or are protected from Oregon tax by PL 86‑272 (a federal statute that generally prevents a state from imposing a net income tax an out-of-state business where the in-state activities of the business do not go beyond soliciting sales of tangible personal property). Oregon payroll also can result in nexus from so-called “bright-line presence” for the CAT.

Potential Trap for Oregon Employer With Employees who Live in Washington

Because Washington does not have a personal income tax, the income tax withholdings risks described above do not arise for Oregon employers with Washington employees who now must work from home. However, an Oregon employer may still have risks arising out of Washington employees working from home.

Effective January 1, 2020, Washington revised its nexus standard, adopting a uniform standard for all B&O tax classifications as well as sales tax collection. Now any business with either (1) $100,000 or more of gross income sourced or apportioned to Washington or (2) physical presence in Washington, is subject to B&O tax. A business that meets either standard that makes retail sales sourced to Washington is also required to collect Washington sales tax.

Note that the $100,000 gross income threshold for 2020 is a material drop from the prior economic nexus thresholds -- $285,000 in 2019. Because businesses that exceed the $100,000 standard have nexus without regard to physical presence, it is only businesses below the $100,000 Washington income threshold that will potentially be impacted by the physical presence nexus standard. Historically, the Washington Department of Revenue has been aggressive in its approach to physical presence nexus, asserting that temporary presence in Washington by either employees or independent contractors is sufficient to create physical presence nexus. The WDOR’s website currently lists “having an employee working in the state” as one of a list of events that will trigger physical presence nexus.

Potential Benefit for Washington Employee who Normally Works in Oregon

Oregon taxes nonresidents only on Oregon-source income, including compensation for services performed in Oregon. If a nonresident works both within and without Oregon, Oregon-source income generally equals the product of (1) total wages and (2) the ratio of (a) days worked in Oregon to (b) total days worked. Washington residents who previously only worked in Oregon generally would not have applied this ratio. Now, these employees should keep track of the number days worked from home and the total number of days worked. This will be especially important if the employer does not change its payroll practices and continues to withhold Oregon income tax during this period, as if the employee still worked in Oregon. These employees generally will be entitled to a refund, but will need the information about days worked to calculate that refund.

The law of unintended consequences applies to sudden changes in the way businesses and employees operate, with both detrimental and beneficial effects. Although the above discussion focuses on Oregon and Washington, remember that these same principles apply across any border, including many municipal borders and certainly international borders. If you would like to know more about these issues, or other matters such as unemployment insurance contributions or Secretary of State registration, please contact a member of our State and Local Tax Practice: Eric Kodesch, Brett Durbin, Scott Edwards, John Gadon, Lewis Horowitz or Justin Hobson.