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Dear Littler: You alerted us to some wage & hour and leaves & benefits issues stemming from our “wandering workers” who have scattered across the country during the pandemic, yet continue to work for our Texas-based company. We have some new questions for you. We received calls this week from two very upset employees. One has been caring for his parents off and on in Duluth since April 2020. He has continued to work for us when he’s in Minnesota, but still has a home here in Texas where he checks in periodically. He is surprised we have been withholding Minnesota income taxes, as he never paid such taxes in Texas. Who is in the right here? Our other employee, who was pregnant and concerned about the low COVID-19 vaccination rate in Texas, temporarily relocated to her sister’s home in New Jersey during the last few months of her pregnancy, all the while continuing to work for our company. She recently gave birth and applied for NJ Paid Family Leave benefits, but was denied. She’s claiming that we should have made New Jersey family leave insurance withholdings. Is she correct? Finally, both employees are asking us to cover their internet service. Would these payments be considered taxable expenses?
—Worried & Wondering about Taxing our Travelers
Dear Worried & Wondering,
These issues are, indeed, taxing. And complicated. There is a lot to unpack, so let’s start with your employee who has been working in Minnesota. Texas, as you know, does not have an income tax. But employers must withhold and remit income taxes to each state where required, and the states have very different rules about when such taxes must be withheld. For example, New York has a 14-day rule that provides that if an employee is working in the state for 14 days or less per year, then there is no income tax withholding. New Jersey and Mississippi use dollar thresholds. In addition, some states have reciprocity agreements that eliminate income tax withholding. For example, if an employee lives in New Jersey but works in Pennsylvania, the employer is not required to withhold Pennsylvania income taxes under an agreement between New Jersey and Pennsylvania.
In your situation, under Minnesota law, if an employer is required to withhold federal income tax, then it also has an obligation to withhold Minnesota income tax. So as long as the employee earned anything while working in Minnesota and had federal income tax withheld, you are correct for withholding state income tax as well.
In addition, Minnesota, like most states, also says if you are living in the state for more than 183 days (roughly half the year), then you’re a resident subject to income tax. You noted the employee has been traveling back and forth from Texas during that time, so we are not sure how long he has been in Minnesota versus Texas, but it is possible that he is subject to income tax withholding as a Minnesota resident even though he kept his house in Texas and travels back. It is also possible that the Minnesota income tax withholding was too much because he was not a resident and still in Texas a substantial amount of time, but that’s a separate issue he’ll need to take up with the state of Minnesota by filing a nonresident tax return and claiming a refund. What we do know is if you hadn’t withheld any income tax, you could have subjected the company to potential penalties for under withholding. It bears noting that most states have tax withholding forms and employment insurance benefits notices that should be given to employees when they move to a new state.
That brings us to your second employee who is working from New Jersey. Unlike income taxes, which can be withheld in multiple states, employment or payroll taxes are paid to only one state. How do you determine which state? All states use the same the same four-part test, which considers: (1) localization of services; (2) base of operations; (3) place of direction and control; and (4) state of employee’s residence.
This test must be applied in hierarchical order; that is, an employer must first determine if the work is localized to a particular state before the next step is considered. An employee’s services are “localized” in a particular state if all or most of the employee’s services are performed in that state, with only incidental services performed elsewhere (for example, where the out-of-state service is temporary or transient in nature or consists of isolated transactions). Where the services performed outside of the state are either permanent, substantial, or unrelated, it cannot be treated as localized to a particular state.
In many cases, it is clear that services are localized in a particular state. If so, that is the end of the analysis. It is unclear from the facts you provided, however, whether Texas or New Jersey is the appropriate state. What work does she perform? How long has the employee been in New Jersey? Does she intend to stay there for an appreciable amount of time, or is she headed back to Texas?
If the employee’s services are not localized to a particular state, then the next step is the base of operations analysis, which focuses on the place the employee customarily returns to receive instructions or supplies, to repair equipment, or to perform other functions relating to the provision of services. In your case, it appears as if the base of operations is indeed Texas, but we would need more facts from you to be certain.
If the employee’s services are neither localized, nor subject to a base of operations, the third consideration is the place of direction and control, which is often a corporate or regional headquarters where the employee gets instructions. As noted in part two of this test, it seems fair to assume, given the information you provided, that Texas is where the employee is receiving her instructions.
If, however, none of the previous factors provides a clear answer, then payroll taxes are due to the employee’s state of residence. Because it sounds like New Jersey is a temporary location, it seems reasonable for you to continue reporting your employee to Texas for payroll tax purposes. This means you are likely not on the hook for the family leave insurance payments that are part of a New Jersey-based employee’s payroll taxes. If the employee continues to work out of New Jersey, however, you may need to revisit the issue.
Turning to your business expense question, some states require employers to reimburse their employees for business expenses—but most do not, including the states at issue here. If a business chooses to reimburse workers for business expenses, it can do so on a nontaxable basis if the employee substantiates the business purpose and nature of the expense, usually by way of an expense report with receipts that is submitted within a reasonable period of time, and is reimbursed only the exact amount claimed. Alternatively, an employer can reimburse employees a flat amount without regard to actual expenses. In such cases, the expense reimbursement is taxed as a wage for federal and state tax purposes.
IRS guidance has clarified that employers can reimburse employees for the reasonable expense of using their personal cell phones on a non-taxable basis. This principle should hold true for internet service, although it is important to recognize that not all use of home internet is a business expense. As a result, some allocation of a reasonable amount to reimburse for the business use must be made, as opposed to just paying employees’ internet bills. This assessment typically requires employers to make reasonable inquiries regarding costs and business usage.
In sum, Worried & Wondering, there are different ways to reimburse employees for their internet expenses related to work, but you’ll need to decide whether you want to provide them a flat amount per week or month to cover expenses while they work remotely and not worry about receipts, or if you want to make the payments nontaxable and collect the necessary information and documentation to ensure payment of no more than covers the business expenses.
As you can see, the tax implications of wandering workers can be thorny and are highly dependent on location. It is therefore key that you keep tabs on where your employees are performing their job tasks and for how long.