The problem was illustrated last year by a case in which a Maryland-based company, TeleBright Software Corp, was ruled to be doing business in New Jersey and liable for state taxes there because the firm employed a single telecommuter in the state. The company appealed the decision and now that ruling is in as well. The result offers no cheer for fans of remote work, as CFO magazine reports:

In the latest ruling of a state court on the issue of nexus — taxation based on location — a New Jersey appeals court held on March 2 that employing a telecommuter in another state subjected Telebright Corp., a Maryland-based software developer, to the N.J. Corporation Business Tax (CBT).

The employee in question in the case developed and wrote software code from a laptop computer in New Jersey… The employee began working for Telebright in Maryland in 2001. But in 2004, she moved to New Jersey. To retain her services, the company allowed her to telecommute full-time from New Jersey. In Telebright Corp., Inc. v. Director of Taxation, a New Jersey Superior Court found that the company was liable for N.J. CBT because of the activities of its lone employee in the state. This month the appeals court upheld that ruling.

Check out the complete article in CFO for more details of the court’s legal reasoning. While it’s clear that cash-strapped states can certainly use all the revenue they can get. It also seems like they could use all the jobs they can get. The clear takeaway here for those not directly responsible for sorting our their organizations’ tax and legal position is clear – it’s past time that congress makes it easier for workers and firms to take advantage of the flexibility technology offers by clarifying their tax obligations. Any day now, guys.

Has your firm run into any tax worries due to telecommuting?

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New Jersey is not the only state claiming authority to tax a nonresident company simply
because the firm employs an in-state telecommuter. While uncertainty remains about how
states will handle individual cases, the inclination of many state tax departments to assert this
authority is concerning. The trend threatens telecommuting’s growth nationally at a time when the country urgently needs to use it more — to create jobs, conserve oil, decrease carbon emissions and assure business continuity during emergencies, for example.

States facing cases like Telebright should adopt the New Jersey Tax Court’s progressive
understanding of telework. However, they should draw a different conclusion from that
understanding and resist taxing out-of-state employers whose only connection, or “nexus,” to
the state is a limited tele-workforce.

Overview of Telebright

Srisathya Thirumalai was a Maryland resident Telebright employed to write software code. When Thirumalai relocated to New Jersey, the firm retained her as a telecommuter. Telebright had no other employees in New Jersey and did not file New Jersey Corporation Business Tax returns. The Division of Taxation determined it should, because, by employing Thirumalai in New Jersey, Telebright was “doing business” there. Telebright argued before the New Jersey Tax Court that it was not “doing business” within the meaning of New Jersey’s Corporation Business Tax Act (CBT Act) and that subjecting the company to the Act would violate the U.S. Constitution’s Due Process and Commerce Clauses. The court rejected both claims.

The court also noted that a federal statute limiting states’ power to tax the income of
certain nonresident companies was inapplicable. The statute — P.L. 86-272 — bars states from
taxing out-of-state businesses that restrict their in-state activities to soliciting orders for sales
of tangible personal property, as long as the orders are both approved and filled from outside
the state. Because Thirumalai did not solicit orders, P.L. 86-272 did not shield Telebright from
taxation.

The Ruling’s Pros and Cons

The Telebright court rightly treated cross-border telework as a profitable business practice useful to both employers and workers, and the court also underscored the legitimacy of a home office as a worksite. Courts nationwide should embrace the Tax Court’s advanced appreciation of telework.

However, the court’s decision also jeopardizes the growth of telework in New Jersey, harming both the state’s residents and its economy. Companies outside New Jersey concerned about taxation there may well refuse to allow either current or prospective employees from New Jersey to telework. By decreasing telework opportunities, the policy approved in Telebright can also limit employment in the state.

Say someone from New Jersey cannot find in-state work but receives a job offer from a Maryland firm. When her home sale efforts prove futile, she proposes telecommuting. Because the company has no other connection to New Jersey and wants to avoid taxation there, it denies her request. She must turn the job down, needlessly prolonging her unemployment. When New Jersey residents remain jobless for a sustained period, the state clearly loses. Personal income tax revenue falls. Because unemployed people have less to spend, sales tax revenue falls. Reduced sales can cause reduced business income tax revenue. A tax policy undoubtedly intended to raise revenue can easily backfire.

The Trend Telebright Illustrates

Other states, too, are asserting that telecommuters within the state who conduct non-solicitation activities may create income tax obligations for their nonresident employers. Responding to a recent Bureau of National Affairs (BNA) survey, thirty-five states said that a nonresident company’s employment of a non-soliciting telecommuter within the state would, by itself, subject the company to income tax liability (BNA, Inc., Special Report: 2010 Survey of State Tax Departments, Vol. 17, No. 4, April 23, 2010).

However, whether a state would tax a nonresident company in any particular case is not completely clear: “[G]uidance, in the form of case law or statutes setting forth the types of activities that trigger nexus and taxability, is lacking in many states.” Although the survey “fills in essential details,” because “nexus determinations are fact-specific and subject to interpretation, the states’ answers should not be relied upon as definitive policy statements,” BNA says.

To harness telecommuting’s many benefits, states should adopt the Telebright court’s view of interstate telework as interstate commerce profiting employers and employees alike. However, states should not — as the Telebright court did — deter telework by requiring nonresident companies to file income tax returns just because they hire a single resident to telecommute. Even a small group of telecommuters should not trigger tax liability. Rather than saddling nonresident employers with extra tax burdens if they hire some in-state telecommuters, states should offer them tax breaks. Especially in the current economy, states should encourage businesses to hire their residents on terms that do not force the residents to move.

Nicole Goluboff is a lawyer and Advisory Board Member of the Telework Coalition, is the author of “The Law of Telecommuting,” “Telecommuting for Lawyers” and numerous articles on telework.

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The reasons for employers to decentralize workers are becoming harder and harder for businesses, employees and governments to ignore. Telework can help employers reduce costs, avoid job cuts and start hiring. It can help them minimize turnover, assure business continuity during emergencies and boost productivity. It can help employees save on commuting and achieve a better work/life balance. It can decrease traffic congestion, the cost of repairing and maintaining transportation systems, carbon emissions and the nation’s dependence on foreign oil.

However, despite these and other well-publicized benefits of telework, some states maintain a tax rule that frustrates employers and employees trying to use it. The rule — known as the “convenience of the employer” rule — imposes a heavy penalty on nonresidents who telecommute to in-state employers.

To assure that state tax authorities do not impede the growth of interstate telework arrangements, Congress must abolish the convenience rule.

How the “Convenience of the Employer” Rule Works

New York State is notorious for its exceptional drive to enforce the convenience rule. Under the rule there, if a nonresident of the state works for a New York firm and opts to telecommute sometimes — even for most of the year — New York will tax him on 100 percent of his salary: the wages he earns in New York plus the wages he earns in his home state. Because the employee’s home state can also tax the compensation he earns at home, he risks double state taxation for working off-site.

To protect their residents from double taxation, some states grant a credit for personal income taxes telecommuters pay the employer’s state on the salary earned at home. However, even telecommuters offered a credit risk being penalized. When a telecommuter’s state has a lower tax rate than the employer’s state, the telecommuter has to pay the steeper rate on the income he earns at home.

Similarly, telecommuters living in states with no income tax suffer because of the rule. Say a Florida resident telecommutes to his New York employer, traveling to New York on business only a few weeks a year. Although the employee chooses to live and do most of his work in a state with no personal income tax, he may nonetheless be forced to pay state income tax — to New York — on all of his Florida wages.

The additional state tax burden the convenience rule imposes can make telework too expensive for employees. The rule also creates tremendous confusion for them: Determining where they owe income tax if they telecommute — their own state, the company’s state, or both — can be a considerable challenge.

How Businesses Suffer

When employees cannot afford to telecommute, employers cannot tap the business benefits telework offers. In addition, just as employees can be confused about where they owe income taxes, businesses can be confused about where they have to withhold taxes. Compliance with the convenience rule can become so onerous for payroll departments that firms in convenience rule states may be forced to move out. For example, in 2008, a company reported to The New York Times that it was planning to leave New York because it was “blindsided” by the state’s enforcement of the rule (“Telecommuters Cry ‘Ouch’ to the Tax Gods“).

How States Suffer

The convenience rule threatens states where telecommuters live (or where would-be telecommuters live) with an unfair drain on their revenue. For example, if a telecommuter’s state does give him a credit for taxes he paid New York on wages he earned at home, the telecommuter’s state effectively shunts its own revenue to the Empire State. That revenue finances public services in New York (like police, fire and other emergency services), even though the telecommuter often works at home and depends on the services provided by the home state. States struggling with perilous budget deficits -– and with the decisions they have to make about which of their own programs to eliminate -– cannot afford to subsidize the programs in New York.

In addition, workers’ states can lose revenue because:

• Confused telecommuters may mistakenly conclude they owe taxes only in their employer’s state, not the home state;
• Confused employers may mistakenly conclude they must withhold only for their own state, not the states where their telecommuters live;
• Unemployed residents may remain jobless — and without taxable income — longer than necessary, because the convenience rule makes looking for work with remote employers unaffordable;
• Businesses in the home state may earn less taxable income when telecommuting residents are forced to cut their home state spending because the extra state tax bill for telecommuting shrinks the residents’ budgets;
• Businesses in the home state may earn less taxable income when residents who cannot afford the telecommuter tax must commute to their out-of-state jobs everyday and purchase more of the goods and services they need in the employer’s state than in the home state.

Even states that maintain a convenience rule suffer because of it. For example, by threatening the profitability of in-state companies and driving them away, the rule jeopardizes the states’ business income tax base.

The rule also threatens the states’ personal income tax base. In New York, because the rule applies only to employees who spend some days working inside New York, telecommuters can duck the tax penalty by staying out of New York entirely. They may decide, with their cost-wary employers, that they will telecommute full-time. Or, they may look for work in their home states. Either way, once a telecommuter leaves New York for good, New York can no longer tax any of his income. Further, New York’s stores, restaurants and other businesses lose his patronage.

The Federal Solution: The Telecommuter Tax Fairness Act

The Telecommuter Tax Fairness Act (H.R. 2600) is proposed federal legislation that would prohibit states from taxing nonresidents on the wages they earn when physically present in another state, removing the threat of double or excessive taxation for telecommuting across state lines.

The bill was introduced by Representatives Jim Himes (D-CT) and Frank Wolf (R-VA). It has support from a bi-partisan group of lawmakers representing states all around the country, including Connecticut, New Jersey, Maryland, Virginia, Georgia, Massachusetts, Kansas, Illinois, Arizona, Washington State and even New York.

The bill also has endorsements from organizations advocating for telework, transportation, homeowners, taxpayers and small businesses. The telecommuter tax is a needless barrier to telework’s expansion. As Washington weighs how to create jobs, improve the country’s preparedness for pandemics and other emergencies, meet national transportation needs, slow climate change, strengthen America’s energy independence and help secure a prosperous future for both large and small businesses, it should demolish this barrier. The Telecommuter Tax Fairness Act would do just that -– without costing the federal government anything. It’s time to make this bill law.

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