Taxes could go up this filing season for a significant number of Americans who worked at home during the pandemic, as states make competing claims to their paychecks.
Millions of people found themselves working out of their living rooms or bedrooms when lockdowns began late last winter, and very few were thinking of the tax consequences. Now, as employees prepare to file their 2020 taxes, they may find themselves stuck in a battle among states, with billions of dollars at stake.
The rules are complex and vary across the country. In some states, you're technically required to pay income taxes if you work there for just a day or two. In others, it’s 60 days. Employers don’t necessarily know the rules, and, since Covid-19 hit, many don’t even know where their workers are. Some states are already fighting in court over which jurisdiction gets to tax workers’ paychecks, and the Supreme Court has yet to weigh in.
“It’s a mess out there,” said Patrick Duffany, managing partner of tax at CohnReznick. “You need to have rules that taxpayers can comply with and you can administer.” Neither is the case right now, he said.
While some state agencies have relaxed regulations for the pandemic, only about half of states have offered any new guidance. At worst, telecommuters can be struck with double taxation, with two or more states each trying to tax the same income. People who decamped to states without income taxes, like Florida or Texas, could find they still owe a chunk of their pay to a state like New York or Massachusetts. At a minimum, taxpayers face extra paperwork and confusion.
The regulations get especially complicated for temporary residents—for example, people living and working out of vacation homes during the pandemic. The State of Vermont, for example, has explicitly warned New Yorkers: “If you are living at your second home in Vermont for more than two weeks the income earned while you are in Vermont is Vermont income” making it subject to the state's income tax, which has a top rate of 8.75%.
“This is going to be a very big issue,” said Holly Gyles, vice president of tax policy and research at Ayco, a firm owned by Goldman Sachs Group Inc. that offers financial planning to corporate executives. “We are going to see clients with larger tax bills because of these state issues and telecommuting.”
Last year, Massachusetts imposed an emergency rule to tax people working from home in other states whose jobs are usually based in state. New Hampshire, which doesn’t have its own income tax, sued on behalf of its residents. States including New Jersey and Connecticut filed briefs in support of New Hampshire.
Before the pandemic, half a million New Jersey and Connecticut residents would travel into New York City every day for work. In 2020, with so many Manhattan commuters staying home, New Jersey estimates it could be losing as much as $1.2 billion of tax revenue on work performed in New Jersey that is still being taxed by New York.
States like Massachusetts and New York argue they’re just maintaining the status quo at an unusual time.
The situation is confusing for the many Americans who have uprooted their lives in the past year.
In June, Anne Canavati, 27, moved from Washington, D.C., to her hometown of Fort Wayne, Indiana, to save on rent and be closer to her family. She spent a lot time confused about what to do about her taxes, because her employer—a small non-profit—doesn’t have an H.R. department.
She eventually ended up saving money when her employer switched her tax withholding settings to Indiana, which has a rate of 3.23%, from D.C., where her marginal tax rate would have been 8.5%. “I didn’t realize this until my paycheck was suddenly a bit higher,” she said.
Because each state has slightly different rules, the details of where and when taxpayers worked could matter a great deal. “You have to understand the state in question, and then take the next step to make sure you’re preparing accurately,” said Andy Phillips, director at the Tax Institute at H&R Block. “Where you have tricky situations is where states take contrary points of view.”
This article was provided by Bloomberg News.