In a typical tax filing season, state taxes take a back seat to federal returns for Lewis Taub, a tax professional in New York.
But for 2020, state taxes are causing headaches — and potentially costing money — for many of his clients who became remote employees during the pandemic, working from home in a state that's different from where their office is located. Which state gets to tax their income isn't always clear cut.
"It's becoming almost a cottage industry," Taub, a certified public accountant and New York director of tax services at Berkowitz Pollack Brant Advisors, told Yahoo Money.
Many states have yet to issue guidance on how remote workers should be taxed on their income in an unusual year where WFH became the norm. That could leave some workers facing higher state income taxes than they're used to, or potentially getting double-taxed by states reluctant to let go of potential revenue.
Here's what's at stake.
'How you file will totally depend state by state'
One of Taub's clients who relocated to Florida a few years ago found himself moving to and working from his second home in the Hamptons in New York last summer when COVID cases in the south were surging. He ended up staying in the New York home past the summer, triggering some tax confusion.
"Is some of his income subject to New York tax now?" Taub said. "Have they re-established their New York state residency?"
Another client who regularly worked in a New York office, but has been working from his Connecticut home since March, faces potential double taxation on his income. That's because New York taxes income of nonresident workers whose primary office is in the state, regardless if they telecommuted. But Connecticut hasn't established whether the employee is subject to its state tax.
This is not a question everywhere because some states have issued emergency tax guidance to head off the issue.
"A lot of localities said we’re going to give employees a pass and continue to withhold as if people were going to their work," Kathy Pickering, H&R Block’s chief tax officer, told Yahoo Money. "In some areas, there was temporary guidance given. In a number of localities, it’s a non-issue because states have reciprocity."
These reciprocal agreements, usually between neighboring states, allow residents of one state to ask for an exemption from the other state's withholding, so the resident can avoid filing two state tax returns. But a handful of states have laws that tax employees based on their employer's location, like New York.
"If you live and work in a different state, how you file will totally depend state by state," Pickering said. "And some states have put out specific instructions on how to handle it and some have not."
New Hampshire vs. Massachusetts
The Supreme Court may end up ruling on the matter, thanks to a lawsuit filed by New Hampshire in October after Massachusetts required New Hampshire residents to pay Massachusetts income taxes if they normally commuted to the state to work.
New Hampshire, which taxes only interest and dividend income, sued Massachusetts in the Supreme Court for what it called an "unconstitutional tax grab."
"New Hampshire has no choice but to seek relief in our Nation’s highest court," New Hampshire Gov. Chris Sununu said in the press release then. "Massachusetts cannot balance its budget on the backs of our citizens and punish our workers for working from home to keep themselves, their families, and those around them safe."
Fourteen states have filed amicus briefs supporting New Hampshire. It remains unclear when the Supreme Court will take up the case.
'This is a gray area'
In the meantime, tax pros like Taub must file state taxes in a guidance vacuum before the state tax deadlines come up.
"We’re taking positions on the return," he said.
For instance, he's not double-taxing the client who lives in Connecticut but whose employer is based in New York. For the client who moved temporarily to his second home in New York, it depends on how long he stayed there. If you live in the state for at least 183 days in a year, New York considers you a statutory resident, subject to New York state income tax.
"Each state has their own rules that could put you in the teeth of their residency rules," Taub said.
Other states have tougher residency rules, meaning you need to register with the state DMV, have the majority of your assets located in the state, or some other requirement. Fortunately, your employer may do the hard work for you, according to Greg Kling, lecturer of accounting at USC Leventhal School of Accounting and Marshall School of Business.
"If you're working for a company — especially one that, let's say, is multi-state — they're most likely going to make the determination of where you should be paying state tax," Kling recently told Yahoo Finance (video above). "The difficulty comes in when you're a freelancer [or] an independent contractor, figuring out where you're working, who you owe the state tax to."
Kling, Pickering, and Taub recommend that taxpayers who worked in a different state than pre-pandemic times pay a tax professional to deal with these new challenges.
"A regular Joe sitting in Connecticut with an office in New York has to be very careful how he or she files his or her state tax returns," Taub said. "Because this is a gray area and you may not be able to do what was done in prior years."