The COVID-19 pandemic made remote working the new norm globally. Several employees traveled back to their home states and continued to work from home. But this arrangement affects how employees are taxed under the Convenience of the Employer (COE) rule in some US states.
Both employer and employee must be aware of the convenience rule to abide by the wage and taxation laws in the state.
Let us understand the convenience of the employer rule in detail.
What Does “Convenience of the Employer Rule” Mean?
The convenience of the employer rule regulates the income tax of employees working for employers outside their state. According to this rule, remote employees working for an employer in another state are subject to that state’s tax laws.
Essentially, it means:
- Employees working for a business located in states that follow the rule will be subject to double taxation
- These employees must pay income tax in their resident state along with their employer’s state
- It is called Convenience of the Employer because income sourcing depends on whether the employee is working remotely as necessitated by the employer or for their personal convenience.
Which States Employ This Rule?
Previously, an employee would only be subject to tax liability in their resident state in many states. However, several states have adopted the convenience rule due to the rise in remote working after the pandemic.
These five states currently utilize the convenience of the employer rule:
- Arkansas
- Delaware
- Pennsylvania
- New York
- Nebraska
Two other states have adopted a variation of this rule:
Connecticut
It applies a convenience rule that will be in effect only if the taxpayer’s resident state implies a similar law for work performed for an employer in Connecticut.
Massachusetts
It introduced the convenience of the employer rule on a temporary basis for employees working remotely due to the pandemic.
Importance of Convenience of the Employer Rule
The convenience of the employer rule is crucial because it helps the company manage a team of remote workers. This rule eliminates the possibility of tax evasion by remote workers.
It also decreases the employer’s investment costs, including office space, resources/equipment, etc. Employees can manage their equipment and file it under home office deductions during taxation.
Additionally, convenience benefits aim to provide employees with additional time and reduce work stress.
Convenience of the Employer Test
The convenience of the employer test determines if the expenses by the employer for a home office setup or work-related purchases are taxable. The test mandates that any cost borne by the employer for their employee must be for the employer’s convenience.
As per the IRS’s definition, the convenience of the employer means an employer has not provided their employees with the necessary resources to help them work remotely. The employee must arrange their own equipment to work for the employer’s convenience.
If the employee is paying for the expenses that pass the convenience of the employer test, they may be deductible.
Here’s an example to understand the convenience of the employer test better:
David is a team leader. He must meet with his team members for training purposes and to discuss business strategies and targets. David’s office has a provision of a small office space where he can meet with the team members for meetings and perform his routine work.
However, David prefers to work from his home office. He has set up his work desk, which he exclusively uses to conduct meetings and administrative tasks. His home office qualifies for deductible expenses since it is his principal place of business.
But, he cannot claim a deduction because he does not meet the ‘convenience of the employer test’. This is because David’s office provides him with a dedicated office space and does not mandate him to work from home.
The factors that qualify for deductions vary from state to state.
Determining Factors for the Convenience of the Employer Test
Several factors determine the application of convenience of the employer test.
Primary factor
The home office has special facilities/equipment required for a functional workday, which the employer cannot provide.
Secondary factors
One must consider the following for the convenience of the employer test:
- A home office is necessary for employment
- The employer has a genuine business purpose of using the employee’s home office
- The employee uses their home office to perform regular work tasks for the employer’s convenience
- The employee uses their home office location to interact and meet with clients regularly
- The employer does not provide the employee with dedicated office space or work accommodations at any business location
- The employer offers reimbursement to the employee for expenses in setting up the home office (there is an 80% norm for reimbursement)
Other factors
The convenience of the employer test requirements also include the following:
- A separate phone line and listing for the home office
- The address of the employee’s home office must be listed on the employer’s business card/official letterhead
- There is a designated area separate from the living area meant for exclusively conducting the employer’s business
- If the business involves selling wholesale or retail products, the inventory is stacked in the home office
- The employee maintains the employer’s business records in their home office
- The home office location has a sign denoting it is a place of business
- Company advertisements show the employee’s home office as one of the employer’s places of business
- There is a business insurance policy for the home office
- The employee is not appointed as an officer of the company
- The employee is entitled to claim deductions for home office expenses for federal tax filing purposes
- Individual states may have other factors and rules for the convenience of the employer test.
Is the Convenience of the Employer Test Challenged?
The convenience of employer test is currently applicable in five states, but the constitutionality of this rule has been challenged in court in New York.
The main challenges to this rule include:
- It violates the Dormant Commerce Clause that prohibits states from burdening interstate commerce
- It also violates the Due Process Clause that requires taxpayers to have minimum contact before imposing a state tax
- The rule also does not reasonably allow the income earned for work performed in another state
- The rule allows states to tax and source income from both non-resident employees and businesses within the state borders
- Post pandemic, corporate culture has adopted remote working and flexible working conditions. Several companies allow work from home to retain talent across the country. COE rules fail to consider this change in work culture.
What are the Implications of the Convenience of The Employer Rule?
With the increasing adoption of the remote working culture, the number of states implementing the convenience of the employer rule is gradually increasing. Although employees in some states receive an income tax credit for paying taxes in other states, it is not enough.
The main problems faced by employees are:
- The tax credit based on the state tax can be lower than the tax rate from that of the employer’s state
- The resident state gives credit waivers to claim taxes paid to other jurisdictions. But different rules within states can result in double taxation on the same income
The Department of Taxation and Finance has not made any announcements to make this a mandatory rule.
Frequently Asked Questions
Q. What are convenience benefits?
Convenience benefits are services or products meant to provide employees with additional time away from work. These facilities ease the employee’s personal to-do list giving them more time to focus on their work and maintain a work-life balance. For example, a canteen service or free food in the office will reduce the stress of cooking their lunch every day.
Q. What does the reciprocal convenience rule mean?
A reciprocal convenience rule means the state only applies it to workers who are residents of a state that imposes the convenience of the employer test as well. Connecticut is the only state that follows a reciprocal convenience rule.
Q. Are there any exceptions to the rule?
To qualify as an exception to this rule, an employee must prove that they must perform their work remotely. If an employee from a New York company is given a task that can only be fulfilled in New Jersey, they qualify as an exception if it is impossible to do the work in New York.
