NH vs MA
Last week, the U.S. Supreme Court denied New Hampshire’s request that the Court exercise its original jurisdiction under the Constitution[i] to hear and resolve a conflict involving the taxation by Massachusetts of income earned by certain residents of the Granite State.[ii]
The disagreement between the two jurisdictions originated when Massachusetts, in response to the pandemic last year, ordered businesses in the Commonwealth to close their physical workplaces and facilities.
Notwithstanding these closures, Massachusetts indicated it would continue to treat as Massachusetts source income, and to impose its personal income tax upon, all compensation received by a nonresident employee for services rendered to a Massachusetts business if, immediately prior to the order, the nonresident employee was engaged in performing services in Massachusetts, and only began telecommuting from a location outside the Commonwealth due to a pandemic-related business closure.
What ensued was a dispute between the two New England neighbors, which culminated in a Constitutional challenge when New Hampshire – which does not have a personal income tax – filed a complaint in the Supreme Court,[iii] in October of 2020, claiming that Massachusetts was infringing upon New Hampshire’s sovereignty by seeking to impose a tax upon New Hampshire residents in respect of income they earned in New Hampshire, not in Massachusetts.[iv]
The disagreement between the two States caught the attention of similarly situated Mid-Atlantic neighbors; specifically, New Jersey and New York.
State Taxation of Nonresidents
It has long been accepted that a State may tax a nonresident individual only with respect to the individual’s income that is earned from sources within that State; for example, rental income from real property located in the taxing jurisdiction.
The same source-based limitation applies to the case of a nonresident individual who is employed by a business that operates within the taxing State; specifically, that State may tax the nonresident employee’s wages, paid by their resident employer, only to the extent such wages are attributable to services rendered – i.e., earned – by the nonresident employee within the State; the taxable portion of such wages is usually determined by comparing the number of days worked by the nonresident within the taxing State with their number of days worked outside the State.
In other words, those wages earned by a nonresident employee for work performed outside the State may not be taxed by the State, and the resident employer is not required to withhold such taxes on behalf of the State.
New York and Nonresidents
In the case of a nonresident employee who performs services for their employer both within and without the Empire State, New York’s tax law resembles that of other states; it provides that the nonresident’s income derived from New York sources includes that proportion of their total compensation for services rendered as an employee which the total number of working days employed within New York bears to the total number of working days employed both within and without New York.
However, any allowance claimed for days worked outside New York must be based upon “the performance of services which of necessity, as distinguished from convenience, obligate the employee to out-of-state duties” in the service of their employer.[v]
NY, the Pandemic and Telecommuters
Coincidentally with the filing of New Hampshire’s complaint against Massachusetts last year, New York’s Department of Taxation and Finance (the “Department”) issued guidance regarding the income taxation of a nonresident employee whose assigned or primary office was in New York.[vi]
According to the Department, the days spent by such a nonresident telecommuting during the pandemic would be considered days worked in New York unless the nonresident’s New York employer had established a “bona fide employer office” at the nonresident employee’s telecommuting location (basically, their personal residence in New Jersey).
Thus, unless the New York employer of a nonresident telecommuting employee specifically acted to establish an office at the employee’s telecommuting location in the Garden State,[vii] the nonresident employee would continue to owe New York personal income tax on income earned while telecommuting from outside New York.[viii]
The guidance issued by the Department was consistent with New York’s long-standing, and much criticized, “convenience” rule, under which a nonresident employee whose assigned or primary office is in New York, but who spends a “normal work-day” at their home office outside New York, will nevertheless be treated as having worked in New York on that day, unless the nonresident employee can demonstrate that their home office is a bona fide employer office.
Several factors are considered in determining whether a nonresident’s New York employer has established such an office at the employee’s telecommuting location outside New York; specifically, in the State in which the employee resides (New Jersey, for our purposes[ix]).
These factors are divided into three categories: the primary factor, secondary factors, and other factors. For an office to be considered a bona fide employer office, the office must meet either: (a) the primary factor,[x] or (b) (i) at least 4 of the secondary factors,[xi] and (ii) 3 of the other factors.[xii]
In general, unless the employer specifically acted to establish a bona fide employer office at the nonresident employee’s telecommuting location, the nonresident employee will continue to owe New York income tax on income earned while telecommuting.
Should the Rule Have Applied?
The question, of course, was whether it was appropriate for New York to apply its “convenience” rule given the circumstances under which so many nonresident employees were telecommuting.
There was nothing voluntary about their decision to work from home. Indeed, Governor Cuomo had declared a state of emergency and ordered all non-essential workers to work from home.[xiii]
Although New York may defend its taxation of nonresident employees, in part, by reminding them that they were entitled to a credit against the tax owing to their state of domicile (New Jersey) for the tax paid to New York – thereby avoiding double taxation of such wages – such a credit had the effect of siphoning tax dollars from the nonresident employee’s state of domicile and into New York.
Indeed, within days of the issuance of New York’s guidance and the filing of New Hampshire’s complaint against Massachusetts, the New Jersey Legislature directed the State Treasurer to prepare and submit a report concerning New York’s taxation of the income earned by New Jersey residents, to determine how much credit New Jersey gives its residents for taxes paid to New York, and to make recommendations for how New Jersey may resolve the “inequitable tax treatment” of New Jersey residents who commute to work for employers in New York. The Legislature also requested that the State consider participating in the above-referenced litigation commenced by New Hampshire.[xiv]
In support of its actions, the Legislature explained that: thousands of New Jersey residents (over 400,000), many of whom work from home, have New York income taxes taken from their paychecks because their employers are located in New York; New Jersey allows these residents to claim a tax credit against their New Jersey income tax liability for the taxes they paid to New York, so that their income is not taxed twice (once by each State); it is inequitable that New York receives and retains income tax revenue from New Jersey residents who may only infrequently travel to New York to conduct business; the inequities have been growing over time as improvements in technology have hastened the trend of New Jersey residents no longer truly working in New York – i.e., telecommuting – and allowing New York businesses to decrease office space available to New Jersey residents working in New York, and effectively use New Jersey’s infrastructure and services as support for their employees.
In its amicus brief, New Jersey described its experience with New York’s efforts to tax New Jersey residents, and urged the Supreme Court to rule in favor of New Hampshire and, by extension, New Jersey.
According to the amicus brief, New York levies taxes on nonresident employees for income they earn while working at home in their New Jersey residences. The imposition of these taxes, the brief claimed, was inconsistent with the Federal Constitution because they are not “fairly apportioned.” The “central purpose” of the fair apportionment requirement, the brief continued, is “to ensure that each State taxes only its fair share” of a tax base. A State does not tax its “fair share,” the brief asserted, when the State directly taxes the income that nonresidents generated outside the State’s borders by working from home.
In urging the Court to exercise its original jurisdiction to accept New Hampshire’s petition, the amicus brief illustrated the impact of the Massachusetts and New York tax schemes as follows: “As New Hampshire highlights, an individual who spends her day working at home in New Hampshire could be required to pay Massachusetts taxes on her entire income, even though her Home State [New Hampshire] (where she spent the entire month) levies no such tax. . . Similar rules apply . . . to the . . . New Jersey residents who work most days from their . . . Jersey City apartments for a company based in Manhattan.”
In addition, according to the brief, the taxes paid by these nonresident taxpayers to New York have had an adverse effect upon New Jersey’s finances because, to mitigate the risk of double taxation on its residents who have New York source compensation income, New Jersey voluntarily provides a credit to its residents for taxes these residents have paid to New York. As a result, New Jersey has sacrificed billions of dollars in tax revenue, while New York has enjoyed a windfall.
This is particularly troubling, the brief asserted, because New Jersey provides police, medical and other services to its residents who telecommute to New York jobs while working at home in New Jersey without collecting taxes on the wages earned by these residents.[xv]
The issue of telecommuting preceded the pandemic and the resulting shutdown[xvi] of many segments of the economy.
However, the pandemic-inspired “work-from-home” orders – like those that were issued by Massachusetts and New York more than a year ago – gave employees, including many who may not otherwise have thought about telecommuting,[xvii] a taste of what it was like. For various reasons, a lot of folks enjoyed it; indeed, to the point where employers are now promising employees the flexibility to telecommute on a regular basis (though not fulltime) and are reassessing their need for office space.
In turn, this change in work habits and expectations will bring into sharper focus the question of when it is appropriate for a State to tax the wages earned by nonresident telecommuters.
The Supreme Court’s refusal to enter this debate, last week, leaves open the possibility that a State in which a telecommuting employee is domiciled may try to tax the nonresident business that employs this individual by claiming that the regular presence of the resident employee, especially one who is a highly compensated decision-maker, creates nexus between the State and the nonresident business.
This option will certainly be attractive in the case of States, like New Jersey, which are fiscally tied, in a sense, to a more economically robust neighbor.
Of course, many States have already expanded their definition of nexus. New York, for example, now imposes its income tax upon a nonresident business which derives receipts of $1 million or more in a taxable year from activities conducted in the State, without regard to whether the business otherwise exercises a corporate franchise, does business, employs capital, owns or leases property, or maintains an office, in New York.
This approach may find support in the Supreme Court’s reasoning in South Dakota v. Wayfair,[xviii] in which the Court adopted the economic nexus standard after recognizing the impact of e-commerce. When considered together with the Supreme Court’s refusal to hear New Hampshire’s case against Massachusetts, many States may be encouraged to treat the confluence of e-commerce and the physical presence of a telecommuting employee – especially of one performing a not insignificant function for an out-of-state business – as sufficient economic nexus for purposes of taxing such business.
[i] Article III, Section 2.
[ii] https://www.supremecourt.gov/docket/docketfiles/html/public/22o154.html . No explanation was given. Justices Thomas and Alito would have granted the motion. Four of the nine Justices must vote to accept a case. (I wish they had.)
[iii] https://www.governor.nh.gov/sites/g/files/ehbemt336/files/documents/nh-v-ma-action.pdf .
[iv] Dare I say it? “Taxation without representation.” It is appropriate to mention it during this, of all weekends. The slogan had its genesis in the Colonies’ response to the Stamp Act of 1765. It resonates to this day.
[v] 20 NYCRR 132.18.
[vi] https://www.tax.ny.gov/pit/file/nonresident-faqs.htm#telecommuting . Updated June 30, 2021.
[vii] https://www.nj.gov/nj/about/facts/nickname/ . Those of you who are regular readers of my posts are no doubt keenly aware that it has been several months since I last referred to New Jersey in derogatory terms. There is something about living in a glass house.
[viii] https://www.tax.ny.gov/pdf/memos/income/m06_5i.pdf .
[ix] No offense is intended toward Vermont, Massachusetts, Connecticut and Pennsylvania.
[x] The employee’s duties require the use of special facilities that cannot be made available at the employer’s place of business, but those facilities are available at or near the employee’s home.
[xi] The home office is a requirement or condition of employment; The employer has a bona fide business purpose for the employee’s home office location; The employee performs some of the core duties of his or her employment at the home office; The employee meets or deals with clients, patients or customers on a regular and continuous basis at the home office; The employer does not provide the employee with designated office space or other regular work accommodations at one of its regular places of business; Employer reimbursement of expenses for the home office.
[xii] The employer maintains a separate telephone line and listing for the home office; The employee’s home office address and phone number is listed on the business letterhead and/or business cards of the employer; The employee uses a specific area of the home exclusively to conduct the business of the employer that is separate from the living area. The home office will not meet this factor if the area is used for both business and personal purposes; The employer’s business is selling products at wholesale or retail and the employee keeps an inventory of the products or product samples in the home office for use in the employer’s business; Business records of the employer are stored at the employee’s home office; The home office location has a sign indicating a place of business of the employer; Advertising for the employer shows the employee’s home office as one of the employer’s places of business; The home office is covered by a business insurance policy or by a business rider to the employee’s homeowner insurance policy; The employee is entitled to and actually claims a deduction for home office expenses for federal income tax purposes; The employee is not an officer of the company.
[xiii] https://www.governor.ny.gov/news/governor-cuomo-signs-new-york-state-pause-executive-order .
Massachusetts rescinded its order effective June 15, 2021. https://www.mass.gov/news/governor-baker-issues-order-rescinding-covid-19-restrictions-on-may-29-and-terminating-state-of-emergency-effective-june-15 .
New York rescinded its order effective June 25, 2021. https://www.governor.ny.gov/news/no-210-expiration-executive-orders-202-and-205 .
[xiv] https://www.njleg.state.nj.us/2020/Bills/S3500/3064_I1.PDF .
New Jersey’s brief was filed in December 2020: https://www.supremecourt.gov/DocketPDF/22/22O154/164460/20201222111244937_22O154_Amicus%20Brief.pdf .
[xv] “Yet that is the Hobson’s Choice to which [New Jersey is] put: doubly tax residents’ income or suffer fiscal consequences.”
[xvi] It feels like ages ago.
[xvii] Me included. I did not care for it. In fact, I returned to the office fulltime more than a year ago.
[xviii] 138 S. Ct. 2080 (2018). The Court there held that a State could require an out-of-state seller to collect and remit sales taxes to the State on sales to residents of the State even when the seller had no physical presence in the taxing State. Almost every State subsequently enacted an “economic threshold test” for the imposition of sales tax.