Income Tax Withholding Pandemonium?

The smash success of the Michael Jordan documentary during the early weeks of the pandemic had millions of U.S. viewers wishing that they could “Be Like Mike.” Now, as the magnitude of state budget revenue shortfalls caused by the pandemic becomes painfully clear, many departments of revenue are hoping they can tax newly remote workers as if they were Michael Jordan in his heyday.

Most states can currently impose income taxes on workers who spend a certain amount of time working within state boundaries during the year. Some states and cities also impose their own payroll taxes. More than 20 states set that time limit (or nexus) at a single day, as the Wall Street Journal’s Laura Saunders notes. These stipulations have for years produced rewarding sources of revenue when applied to Michael Jordan and today’s superstar athletes—especially those with annual salaries north of $20 million. California collected some of Jordan’s income tax, for example, when the Chicago-based player had road games in Los Angeles, Sacramento and Oakland.

But when and how should state income taxes be withheld during a pandemic when millions of workers shifted to remote working models, often based in states other than those where they previously commuted to brick-and-mortar offices?

The answers vary, but many states agreed that the current rules would still apply: taxation of the employee occurs at the original place of work location where the services are performed, not the new temporary remote work location. The issue has grown more complicated as income-strapped states scramble to draft COVID-19-related clarifications or bills to enhance revenue collection, with payroll tax withholding being front and center in a few of these. What is clear is that payroll tax withholding is a key revenue source to leverage to “pay for” the COVID-19 impact. As such, the nexus and convenience of the employer rules adopted by some states will need to be reviewed, as they may not be fit for this purpose in a post COVID-19 permanent remote working environment. A recent article by Alvarez & Marsal highlights: “In addition to understanding the specific withholding requirements of the states involved with the workforce population, it will be crucial for employers to determine when COVID-19-related work from home arrangements are no longer considered temporary, resulting in any COVID-19 related exceptions no longer applying.”

As state revenue gaps widen, more legislators and tax authorities will take a much closer look at this issue and important source of income. In other words, this is not the “last dance,” as states can be expected to make additional moves related to this matter.