As 2020 comes to a close, many small business owners are concerned about the complexities of filing their tax returns after a significant shift in their business operations and workforce distribution. We’ve already covered how telecommuting employees may establish a tax nexus in their state of residence, but additional fears about being taxed in multiple states are on the minds of many entrepreneurs. According to Accounting Today, W2s issued in 2021 will likely look very different than those prepared in previous years. With states having different regulations when it comes to how taxation is determined, accounting professionals are doing their best to anticipate their state’s withholding guidelines.
Luckily, some states are beginning to issue rules regarding taxable income on a state-by-state basis. Some states are even holding reciprocal tax agreements with neighboring states. Thanks to these accords, the states involved are choosing to tax based on residency, meaning that if employees have worked in multiple states, they are taxed in the state where they are primarily based. While this is a huge weight lifted off the shoulders of employees who earn W2 wages, business activity is not privy to the same regulations and may be more difficult to figure out depending on where work is conducted.
A new era of tax nexus law began after a 2018 Wayfair case, which confirmed that states can charge sales tax for online purchases made in the state even if the business has no physical presence there. Since a tax nexus is established between the state and a business based on employee residency and where products are sold, 36 states report that they consider a nexus established with a business when even one employee works from within their borders. This has the potential to be a giant headache for small business owners who have established work from home policies in response to COVID-19 and now have employees working all over the country. Even if they are working from a vacation home, as Accounting Today points out, a nexus may still be established. According to CPA Lori Roberts, who was interviewed by Accounting Today for their article on this matter, tax professionals are urging business owners to be patient as we all wait to see what states will do in regard to exercising nexus statues.
In order to protect yourself from the effects of a potential audit, keep detailed reports of where your employees are working. You may even want to establish rules within your telecommuting policy that limit employees to working within their state of residence. If you do have a distributed workforce, be sure to read our article “Businesses With Telecommuting Employees May Save on Taxes” to ensure you aren’t overpaying local and municipal taxes.