July 7th, 2021

Supreme Court Declines to Clear Up Telecommuter State Tax Issues Triggered by the Pandemic

One outcome of the COVID-19 pandemic is that remote work arrangements (whether full-time or hybrid) are here to stay. These arrangements raise difficult tax issues when employees work from home in one state for an employer whose office is in another state because the patchwork of state income tax rules applicable to such arrangements are often inconsistent and confusing. This confusion affects not only state withholding/personal income tax laws, but also employer nexus and corporate income tax obligations, unemployment insurance contribution requirements and compliance with wage/hour and employment laws. Until this situation is clarified, an employee working from home in New Jersey whose employer’s office is in New York, for example, will remain subject to income tax in New York even if the employee performs no services in New York.

Against this backdrop, employers and employees were hopeful the Supreme Court would clarify this situation in State of New Hampshire v. Commonwealth of Massachusetts (No. 22O154). Unfortunately, on June 28, 2021, the Court declined the opportunity to rule, leaving significant tax questions unanswered. Here’s a summary of what was at stake in this interstate dispute, and a look at the path forward.

State of New Hampshire v. Commonwealth of Massachusetts. At issue was New Hampshire's complaint involving a Massachusetts temporary regulation subjecting New Hampshire residents working remotely from home for Massachusetts employers during the COVID-19 pandemic to Massachusetts income tax on their income from such employment. Significantly, New Hampshire was asking the Supreme Court to consider the complaint pursuant to the Court’s so-called “original jurisdiction” – meaning the matter would be heard initially in the Supreme Court, rather than after trials and appeals in state and lower federal courts (like most Supreme Court cases).

The Massachusetts regulation. The Massachusetts regulation in question was issued shortly after the start of the COVID-19 pandemic. It provided that nonresident employees who worked in Massachusetts before the state of emergency were required to treat their wages as Massachusetts-sourced in the same proportion as immediately before the pandemic, regardless of where these employees were now working. New Hampshire, which does not tax its residents’ compensation income, complained that the Massachusetts regulation violated the U.S. Constitution's Due Process and Commerce clauses by imposing income tax on workers who were not providing any services in Massachusetts. The essential issue in the case, according to New Hampshire, was whether "Massachusetts may tax New Hampshire residents for work performed entirely within New Hampshire simply because those individuals once commuted to Massachusetts for work." New Hampshire argued that while it does not have an income tax, "the mere possibility of double taxation is forbidden" under the Commerce Clause. Massachusetts argued that the Court should not exercise its discretionary original jurisdiction to review the case, inasmuch as its original jurisdiction should not apply to “a collectivity of private suits ... for taxes withheld from private parties,” that New Hampshire did not have standing to bring the suit, and that its emergency regulation did not violate the Commerce and Due Process clauses.

Why did the Supreme Court decline to rule? A number of friend-of-the-court briefs were filed, including one, at the Court’s invitation, by the acting US Solicitor General, who argued that (1) New Hampshire’s claims did not justify the Court’s exercise of original jurisdiction; (2) the issues raised by New Hampshire’s complaint could be adequately presented and litigated by New Hampshire residents subject to the Massachusetts income tax; and (3) New Hampshire’s constitutional claims would be more appropriately addressed in the context of a fully developed factual record involving affected individuals and after Massachusetts judicial interpretations of the relevant tax provisions. The acting Solicitor General’s brief also noted that a dismissal of New Hampshire’s suit would not necessarily preclude nonresident employees from challenging the Massachusetts regulation as applied specifically to them and pursuing personal income tax refund claims.

While the Court offered no comment on its decision to decline the case, it appears that the Court may have agreed, at least in part, with the acting US Solicitor General’s arguments.

The Massachusetts regulation can be viewed as a temporary application of the “convenience of the employer” rule adopted by a number of states even before the onset of the COVID-19 pandemic, including, most notably, New York. Under New York’s rule, a nonresident employee working remotely outside New York whose primary office is in New York cannot treat the portion of his or her compensation attributable to the days worked outside New York as non-New York-source, unless the performance of such services, “of necessity, as distinguished from convenience, obligates the employee to out-of-state duties in the service of his [or her] employer” and the employer has established a “bona fide employer office” at the location of such services. See “Do Telecommuters Working in Another State Owe New York State Income Taxes?” for a discussion of the factors that determine whether an office constitutes a “bona fide employer office.” New York’s highest court has upheld this test as constitutional for decades, and the U.S. Supreme Court has declined to review challenges of those decisions.

Where do we go from here? So, where does the Supreme Court’s refusal to hear the New Hampshire complaint leave us? Unfortunately, it leaves us with at least three unanswered questions.

1) Are telecommuter tax laws such as New York’s “convenience of the employer” rule and Massachusetts’ temporary regulation constitutional? As indicated above, the Supreme Court has yet to address the constitutionality under the Due Process and Commerce clauses of rules under which an employee working remotely in one state is subject to tax on compensation received from an employer located in another state when the employee does not perform any services in that other state. Would such rules be deemed to violate the Court’s internal consistency requirement, which generally prevents taxation of the same income by more than one state, and its requirement of sufficient nexus with the taxing state? In an increasingly mobile and digital world, the Court’s application of these requirements could find new expression, assuming the Court is willing to entertain questions measuring the reach of state taxing power, including source rules.

2) Will individual taxpayers pursue claims in state courts? Are individual New Hampshire residents employed by Massachusetts companies prepared to argue in a Massachusetts proceeding that they were harmed by being taxed on income earned outside Massachusetts? The same question may be asked about individuals resident in other states who have been subject to income tax by the states in which their employers are located even though they have performed no services in their employers’ states. Even if there are individuals willing to pursue such claims, the resolution of such proceedings could take years.

3) Will other states pursue similar challenges? Will states other than New Hampshire in which resident workers are similarly affected by state rules like those in New York and Massachusetts seek to directly challenge such rules? Recent press reports have suggested that New Jersey, which, according to a report from the New Jersey treasurer's office, issued $3.4 billion in credits for income taxes paid to other jurisdictions in 2016, may be a leading candidate to take up this challenge, especially with regard to New York's taxation of New Jersey resident employees of New York employers who are now working remotely from their New Jersey homes.

If you have questions about telecommuter state tax issues or other tax concerns, please contact Jeffrey Marks at (212) 826 5536 or jmarks@fkks.com or any member of our Frankfurt Kurnit Tax Group.