Telecommuters Beware -- New York's Odd Tax Laws Spell Trouble for Employees and Employers
Telecommuting is fast becoming a way of life for employees and employers. Increasingly, employees can set up remote locations from which they perform part of their work for New York-based employers. One might think that the work these employees perform from their employer-sponsored home offices would be sourced, for income allocation purposes, to the state in which the services are actually performed. New York State, however, has rather odd wage allocation rules which make it very likely that telecommuters will find their income from such out-of-state activities treated as taxable New York source income.
New York’s Odd Tax Rule
Under New York law, nonresident individuals are taxable on their taxable income derived from New York sources. In the case of a nonresident employee working partly in New York and partly outside the state, the tax statute provides that the items of income derived from New York sources are determined "by allocation and apportionment under [the tax department's] regulations." Although the regulations provide that the portion of an employee's wages derived in New York is determined by comparing the number of working days in New York to the total number of working days, the definition of a day worked outside New York is quite troublesome.
Specifically, the regulations provide that "any allowance claimed for days worked outside New York State must be based on the performance of services which of necessity, as distinguished from convenience, obligate the employee to out-of-state duties in the service of his employer." This means that if an employee chooses to work at home in New Jersey on any given day because it is convenient for the employee, that day will not be considered a non-New York day.
Necessity v. Convenience
This "convenience of the employer" standard which really is the necessity of the employer -- can be very difficult to satisfy. This rule has generated a good deal of controversy over the years. Two recent New York decisions, Phillips and Friedman, graphically illustrate that even though nonresident employees may actually be working outside the state, their earnings may nevertheless be taxable as New York source income.
Phillips, decided by the State’s Appellate Division (the second-highest court in the State), involved an employee of Lehman Brothers, Inc., who worked out of a home office in Pennsylvania. The facts of the case showed that Lehman provided computers, fax machines, information systems, and 25 phone lines for Mr. Phillips’ home office. His office was listed in the local phone book as "Shearson Institutional Capital Funding;" and his desk on the Lehman trading floor in New York City was inadequate, due to security limitations, to serve the full needs of his job. Lehman itself explained that the nature of Mr. Phillips’ work required that he maintain unconventional hours monitoring overseas markets and making trades, working at times when the New York office was closed, and Mr. Phillips testified that, on days when the markets were volatile, he had to work out of the home office to avoid being "out-of-pocket" during his commute.
Yet all of this was not enough. While Lehman’s letter stated that Mr. Phillips’ "presence in our office is not feasible or practical," the Tax Appeals Tribunal found that "[t]his letter does not explicitly state that petitioner’s presence in New York was not feasible or practical for his employer." The Tribunal held that Mr. Phillips had to treat the days worked in his Pennsylvania home office as New York days. This controversial decision has now been upheld on appeal.
In a December 30, 1999 decision, the Appellate Division ruled that "the Tribunal's conclusion that the evidence submitted by petitioners failed to meet the strict standard required for establishing employer necessity [was] by no means irrational." Referring to one of the few cases (Fass) in which an employee had won by proving that firing ranges, stables and kennels could not be replicated at his employer's New York City office, the Appellate Division described Mr. Phillips' case as "far less compelling." The Appellate Division was "not persuaded that Lehman's offices would not be reasonably adapted to serve petitioner's needs." As a result, the compensation received by Mr. Phillips for services performed in his home office was allocated to New York.
Further appeals are promised. At this point, however, Phillips stands as an important example of the difficulty of allocating nonresidents’ earnings outside the State when they maintain any work connections within New York.
Along similar lines, the taxpayers in Friedman, a recent decision of the Tax Appeals Tribunal, found that New York can tax amounts earned for doing nothing in Florida. Mrs. Friedman was paid $50,000 annually by her husband’s company, but the facts showed that she performed no actual services for the company. Since no services were actually performed, the Tribunal allocated the $50,000 on a pro rata basis over the days in the year. Three-quarters of those days were spent by Mrs. Friedman in Florida. She could not demonstrate that her employer required her to be in Florida while doing nothing, however, and as a result the days she spent in Florida were treated as New York work days. New York was therefore entitled to tax the full $50,000, on the basis she was in Florida for her convenience, not her employer’s necessity.
Practical Impact of These Cases
These recent decisions, which are consistent with a Department Advisory Opinion issued in 1996 to a Citibank telecommuter (Annito), may seem surprising in result. Nevertheless, they clearly describe the current state of New York law, and highlight issues that have become increasingly common as the economy shifts from physical linkage to electronic. Employees who consider themselves based in remote sites outside New York bear a difficult burden of satisfying the State that the location of their work is dictated by the employer’s requirement, and that they could not have performed these same services at the employer's New York office. Even when the employer requires the employee to work out of his home, as Citibank did in Annito, the State will still maintain that the employee cannot allocate unless the nature of the out-of-state services is such that they cannot be performed at the employer's New York office. The result of this difficult standard can be a New York tax on income the employee earned while working out-of-state. And if an employee resides in a state with location-based sourcing rules (which is entirely possible), the employee may have to pay income tax to his or her home state as well, with no offsetting credit for the New York tax paid. This double taxation can occur where different state sourcing rules lead both New York and the home state to claim to be the source of the employee's earnings.
Concern for Employers Too
While troubling for nonresident employees, there are reasons employers should be concerned about New York's sourcing rules as well. Employers may need to review their withholding policies, and consider the extent to which wages paid to nonresident employees may be taxable in New York. The payroll factor utilized in employers’ business allocation formulas also could be implicated by the New York income tax sourcing of an out-of-stater’s work.
Employers not otherwise present in an employee’s home state also should be concerned that if an employee is treated as working in that state to satisfy the employer’s necessity, that may cause the employer to be treated as doing business, and taxable, in that state. Corporate policy may encourage or even require telecommuting, but employers generally do not control where their employees live. If the state in which an employee chooses to set up a laptop treats the telecommuter as establishing a place of business for the employer, that employer’s state (and local) tax burdens may quickly mushroom. This problem exists today; but New York’s unique allocation rules give employees an added incentive to characterize their employers as doing business in their home states. Employers should therefore remain sensitive to the possible conflict, and should exercise care in their support of nonresidents’ allocation claims.
Hope for the Future?
The current state of the law rankles, and has prompted calls for reform. The Northeastern States Tax Officials Association has been asked to look at the problem of inconsistent state sourcing rules and may take steps, much like their recent uniform domicile guidelines, to reduce or eliminate the problem of double income taxation caused by different state tax rules. Given the patchwork of state and local taxation across America, however, a strict test allocating income based on physical location could be extremely burdensome for individuals who travel heavily. It also may not be practical to address the taxation of multi-state employees without also dealing with the issue of where their employers are doing business. The issue therefore may be more complex than it first appears.
In many aspects of state and local taxation it has become clear that the old tax rules are ill-suited for the new economy. New York's sourcing rules governing the taxation of telecommuters and other remote employees is yet another example of this recurring problem.
Tax Law Search7RHSearch7RH601(e), 631©
N.Y. Regulation Search7RH132.18(a)
Phillips v. New York State Department of Taxation & Finance, ___ AD2d ___, 700 NYS 2d 566 (December 30, 1999), aff'g 1999 N.Y.T.C. T-98 (DTA #815489) (April 15, 1999)
In re Friedman, ___ N.Y.T.C. ___ (DTA # 816142) (March 2, 2000)
Fass v. State Tax Commission, 68 A.D.2d 977, 414 N.Y.S. 2d 780 (March 15, 1979)
Mark F. Annito, TSB-A-96(10)I (December 27, 1996)