Tax issues loom for lawyers working out of state

With the increase of remote work, lawyers are thinking about potential tax problems as some of their staff are temporarily working out of state.

While tax withholding has always been an issue for states close to each other, such as New Jersey and New York, the pandemic has made the situation more complicated, according to Douglas W. Schwartz, a partner at Nossaman LLP who specializes in tax issues.

If an employee from California takes advantage of the shutdown and temporarily moves to their family or friends in a different state, issues can arise. Employers must now assess their connection with the state where the employee is currently living.

"Does the law firm have to file tax returns in that state or start withholding from the employee in that state," Schwartz said. "And the employee has an issue if he or she spends enough time in another state. Does he or she not become a resident of that state and pay taxes in that state? That's going to be the big issue because I don't think anybody is thinking about that right now with other personal and business disruptions going on."

According to a survey from the Harris Poll for the American Institute of Certified Professional Accountants, 52% of Americans are unaware of possible tax consequences from not changing their state tax withholding to reflect their remote work location.

Some 71% of the 2,053 people surveyed were also not aware that working out of state can impact the amount of state taxes owed.

According to Elaine Leung, tax director at the accounting and advisory firm BPM LLP, the first step to avoiding getting into trouble is to keep a record of where employees have taken up temporary residence.

Although some companies or law firms could have policies saying that an employee has to let the employer know where the person is working from, it may not be implemented because of unusual times, Leung said.

"In our experience, we hear from companies who are surprised, saying, 'I didn't know that person actually had been in another state,'" Leung said. "And even longer than anyone would expect, maybe a few months and some even could be in one state for a couple of weeks and then the next few weeks in another state outside of California."

But according to Schwartz, an employer must be careful when keeping track of employees to avoid appearing intrusive.

"It is terra incognita here," Schwartz said. "I really don't know how law firms and other companies are going to address this and how states are going to address it. And I suspect, even after COVID-19 is over, the virtual office is probably here to stay."

The California Franchise Tax Board has taken steps to provide guidance. The board recently announced that it would not classify a company whose only connection to California is someone working unexpectedly in the state because of the pandemic as doing business in California.

Since there is a lot of fear about California taxes nationwide, the board's update was important, said tax lawyer Robert W. Wood. But questions remain.

"The way I read it, it was not clear what will happen if you have many employees," Wood said. "What if you have not just one employee. Instead you have five, 10, 20. California did not draw a line, and I think many of the changes will be the subject of tax disputes. Unfortunately, we can't give clear guidance about what is going to happen."

According to Leung, other states are also providing updates, but it can be time consuming to keep track of different taxes that could apply. She encouraged law firms and companies to start thinking about navigating tax-related issues stemming from remote work as soon as possible.

"Some states are good in providing clear guidance on what period you don't have to worry about, while some states are silent," Leung said. "Then, of course, even if you make an effort to comply, it is confusing."