HR Insight: The Convenience of the Employer Rule for Withholding State Income Tax

Small businesses today are finding themselves faced with a changing landscape when it comes to everything tax. One specific area of change is the move being made by states to ensure their coffers are filled when it comes to taxing employees of in-state-based businesses working remotely across state lines.

Currently, there are a handful of states employing what is called the Convenience of the Employer (COE) Rule. This is their effort to smooth out the process of determining who pays what to whom and ensure they get theirs.

Prior to the COVID epidemic and the rapid expansion of remote working, it was the norm for workers to be subject to state tax based on where they live. However, now with the COE Rule, there is the COE test, which gives businesses a basis for systematically identifying which remote employees working out-of-state are subject to having state income tax withheld in the state where the business is located, the state where the employee resides and works, or both.

The states primarily include Connecticut, Delaware, Nebraska, New York and Pennsylvania. New Jersey does not have a Convenience of the Employer Rule per se. Instead, the state recently passed legislation that applies the rule employed by another state to a worker for a New Jersey-based business telecommuting from that state. New Jersey and Pennsylvania also put in place a reciprocal agreement whereby residents from each state are exempted from having tax withheld for services they perform in the other state.

Still, there is a real risk for some remote workers to find themselves being “double taxed” by having to pay tax not only in the state where they live and work, but also in the state where their employer is based.

One surefire way for workers to avoid this situation is simply choosing to live in a state with no state income tax. For the others, it comes down to passing the COE test.

In line with the name of the rule governing its use, the purpose of the test is basically to determine whether an employee is living and working out of state for their own convenience or for the convenience of their employer.

Different factors come into play when making this determination. While the factors might differ to varying degrees among the states, ultimately, the question is the same… “Does the employee home office qualify as a bona fide employer office?”

For more clarity on the issue, the following are the factors for determining according to the COE Rule for the state of New York. In order for a home office to qualify, it must meet either:

• the primary factor, OR
• at least four of the secondary factors AND three of the remaining ten factors.

Primary Factor

The home office contains or is near specialized facilities that cannot be made available at the employer’s place of business.

Secondary Factors

• 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 their 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.

Other Factors

• The employer maintains a separate telephone line and listing for the home office.
• The employee’s home office address and phone number are listed on the business letterhead and/or business cards of the employer.
• The employee uses a specific area of the home that is separate from the living area exclusively to conduct the business of the employer.
• The employer’s business sells products 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 the employer’s place of business.
• 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.

Source: New York State Dept. of Taxation and Finance

It is clear there is much to be considered when it comes to understanding the complexities faced by businesses in support of a remote workforce. The use of the Convenience of the Employer Rule for withholding state income tax is just one area that needs to be addressed.

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