Remote working arrangements are increasingly important in today’s fast-changing world. These setups are convenient and flexible for workers. On the flip side, employers can choose from a wider talent pool.
Whatever side you’re on, you may encounter certain complications, including tax-related liabilities. So, before deciding to go into such scenarios, you need to ask this question: What is the tax implication of working remotely?
Being informed on this matter will prevent any taxation issues in the future. To help you with this, we gathered as much information regarding the tax implications of a remote setup.
Remote Worker Taxes In The United States
Before we go into the tax implications of working remotely, let’s look into the taxes collected from remote workers.
Federal Tax
The federal tax is a combination of income tax and payroll tax.
Income tax is charged for individual annual earnings from salaries, wages, commissions, tips, bonuses, and investment income. This tax goes to the federal government for nationwide programs.
On the other hand, the payroll tax is for Medicaid and Social Security purposes paid by the employer and employee.
State Tax
Like the federal tax, state tax is imposed on income earned in the state and paid directly to it to fund budgets.
Not all states collect this tax, though. Others, however, impose flat or progressive tax payments.
Local Tax
Some localities require employers to collect a local tax from a worker in the area or the vicinity.
This tax can be a city, district, or county tax and funds essential services relevant to the community.
Self-employment Tax
If you’re an independent contractor, you’re considered self-employed. So, payroll tax collection doesn’t apply to you.
Instead, you need to pay a self-employment tax to cover Medicare and Social Security when your net income goes beyond $400.
Remote Worker Taxes Outside Of The United States
Remote working scenarios allow companies to hire people from around the globe. If you employ outside the United States, hires are usually treated as independent contractors.
In this regard, they’re responsible for filing their tax returns. That’s a better setup for hiring entities since other countries also have specific tax laws you need to abide by.
Otherwise, employers need to establish a local legal entity in the employee’s country of residence. In most cases, that entails a long and tedious process.
Another option for hiring entities is to contract an Employer of Record or EOR. This third party will take on the responsibilities of the client employer in that specific country.
Meanwhile, if you’re a U.S. citizen working remotely overseas but employed in a U.S.-based company, you’ll only have to pay taxes in the country where you work. That’s unless you’re a high-earner who meets the annual income threshold.
Either way, you should file tax returns for full disclosure and avoid untoward tax liabilities.
What Is The Tax Implication Of Working Remotely?
As a remote worker, you’re subject to taxation like any other income earner. However, you can get confused about where to pay your dues.
That’s because the truth is, remote tax policies are always changing. They vary across states, too.
So, as practical advice, it’s best to check your state policy. Do a little digging on the department of revenue website to find out what you’re looking for. If that doesn’t work, you can call the department’s hotline for your questions.
Still, here are key points you need to remember:
#1. Taxes On Employees And Independent Contractors
All parties involved—employers, employees, and independent contractors— should know the tax implications of remote working arrangements. That should start with a clear definition of individual roles.
Remote Employees
For example, employees are different from independent contractors. Remote employees are just like their office-based counterparts.
So, if you’re an employer, you need to withhold employment taxes for federal, state, and local payments.
Independent Contractors
When you avail services from independent contractors, you’re not liable for their taxes. They’re considered self-employed and, therefore, they’re responsible for tax payments.
Nevertheless, you have to see to it that they fill out a W-9 form or the “Request for Taxpayer Identification Number and Certification.”
The contractor also needs to complete a 1099 form if payment for services exceeds $600 in a year.
As a safety measure, you can put your arrangements in writing. That said, prepare legal documents detailing the nature of the job and the association.
What Does The IRS Say About Remote Workers?
The IRS reminds businesses regarding the misclassification of remote workers, so make sure contractors are qualified under the IRS definition. Always remember that classifications are covered by federal and state laws.
For example, California has enacted Assembly Bill 5, which aims to protect workers from misclassifications.
According to this law, independent contractors are classified as such, if they meet the following conditions:
- Not controlled and directed by the hiring company
- Provides services outside the business of the hiring body
- Occupation is independently established
Otherwise, companies should treat them as employees with access to benefits and labor and employment protection.
Misclassifying a supposed employee as an independent contractor has serious repercussions. Not only are you subject to tax penalties, but to other sanctions as well.
If a lawsuit is filed against you, you may have to pay wages and overtime. These payments are calculated for the two years preceding the complaint. Worse, you may have to double that amount.
For multiple violations, increased penalties are imposed and may eventually lead to an investigation by the Department of Labor.
#2. Creation Of A Tax Nexus
Some big companies have established tax relationships in different states. However, that may not be true for smaller businesses.
If you’re working in another state where the company has no presence, you create a tax nexus.
In other words, the company will now be subject to tax obligations. That depends on the nature of the business and if it hits the income threshold.
Take, for example, being hired for sales purposes. Your employment alone triggers an income tax nexus.
Once you reach the payroll limit, the company has to file business income tax returns in your state, apart from its location. If your state imposes higher rates, this means a larger tax for the business.
Additionally, your presence will trigger a sales tax nexus. When you meet the minimum requirements, you should collect sales and use taxes from customers to be paid to the state.
Again, you should review laws specific to your state to know which sales are taxable and what limits you’re looking at.
#3. Convenience Of The Employer Rule
If you are working remotely in the same state as the business, tax obligations are similar to being office-based. Your employer withholds a portion of your income for federal, state, or local taxes, whichever is applicable.
But if you’re in another state, it’s more tricky. As mentioned, state policies differ in this regard, and you should learn as much information as possible about your home and work state.
Generally, you need to pay state taxes where the physical work was done—in this case, your home state. However, if you’re in a state under the Convenience of the Employer rule, that doesn’t always apply.
Based on this agreement, you need to pay your income tax in your home state if the work necessitates that setup and is convenient to the employer. Otherwise, if it’s for your convenience, then the tax is sourced to the company’s work state.
Although the provisions seem pretty straightforward, there’s the burden of proving what’s convenient and what isn’t.
For that, you may be charged twice for the same income. To prevent this from happening, you need to file multiple tax returns—a resident tax return in your home state and a non-resident tax return in the company’s state.
Then, you can take the amount of tax you paid and claim it as credit in your home state. But, there’s no guarantee that you’ll get the credit. That still depends on existing state policies.
Moreover, you may be at a disadvantage if the business is based in a state with higher income tax compared to your state of residence. In this case, credit isn’t a one-to-one deal.
The Convenience of the Employer rule applies to the following states:
- Arkansas
- Connecticut
- Nebraska
- Delaware
- Pennsylvania
- New York
#4. Reciprocity Agreements
Certain states are bound by reciprocity agreements, and this may work well in your favor.
If your home state has this arrangement with your work state, you can pay income taxes based on the rules of your residence state. Moreover, if you can provide the required documents to your employers, you also won’t need to file for a non-resident tax return.
For example, Arizona has reciprocity agreements with California, Oregon, Indiana, and Virginia. If you live in any of these states and work in Arizona, you need to submit a Withholding Exemption Certificate (Form WEC).
If you fail to do so, your employer will withhold income tax from your pay and you’ll need to file for separate tax returns. Then, you can claim tax credits for the same amount you paid in your work state.
#5. Residency Audits
Remote work allows you to travel or move between places at your own time and convenience. Yet, it can cause ambiguity in your residence and may lead to taxation problems.
For instance, if you work for a few months in one state and complete the rest of the year in another, you may be taxed in both states. It also gets more complicated if you jump from one state to another several times a year.
In these scenarios, make sure to update both your employer and respective tax authorities for changes in residency. This helps avoid double taxation on your end and penalties for your employer.
On top of that, you should prepare for residency audits. If you frequently travel for work, be ready with proof of your whereabouts on said dates like plane tickets or hotel bookings.
In the case of a permanent move, update mailing addresses and secure driver’s license, voter, and vehicle registration as soon as possible.
Auditors will also likely look into sources of income, the location of your bank accounts, and social connections.
#6. Dual Resident Status
If you reside in one place for too long, you’re also at risk of becoming a dual resident.
Generally, the so-called 183-day rule defines residency. That means you’re a resident only if you’re in a state for at least half a year (183 days).
If classified as such, you may have to remit taxes on both states, which means higher payments.
States like Philadelphia, Kansas, and New York already impose these tax schemes where you have to pay full income tax on all annual income.
#7. No State Taxes
While some states can be stringent in tax collections, others provide tax relief or no tax at all.
If you live in any of these states—Alaska, South Dakota, Nevada, Florida, Wyoming, Washington, New Hampshire, and Tennessee, then you’re in luck! There are no state tax collections in these areas for different reasons.
Still, your employer will withhold part of your income to pay federal taxes.
#8. Aggressive States
The rise of work-from-home setups comes with people moving to lower tax rate areas so they can pay less. As a result, previous work states collect lower revenues.
That’s partly to blame for stricter and more aggressive tax policies. Additionally, tax impositions are constantly changing to maintain revenue streams.
If you work outside the company’s state, tax credits aren’t guaranteed and credit amounts also vary.
For instance, in some states like Kentucky, collections are on a case-to-case basis. Meaning, they get right down to the reason why you’re working remotely.
#9. Home Tax Deductions And Expenses
Previously, remote employees enjoyed tax deductions for setting up home offices. But due to the Tax Cuts and Jobs Act of 2017, only remote workers classified as independent contractors are qualified for this benefit.
If you’re part of this group, you can have deductions for the following:
- Insurance
- Repairs
- Utilities
- Depreciation related to anything in your home office
However, you need to prove that the space is exclusively and regularly used and serves as the primary place of your business.
Reimbursement Of Remote Work Expenses
Take note that remote employees can request reimbursements for work-related expenses. The extent, though, depends on the state.
If you live in the following states — California, Illinois, New York, Washing D.C., Massachusetts, New Hampshire, Iowa, Minnesota, and Montana, you can benefit from existing laws regarding this matter.
Here are typical expenses for reimbursement:
- Internet service
- Mobile and landline phone service
- Laptop
- Computer monitors and accessories
- Tablets
- Data storage
- Postage costs
- Work-related travel and lodging
Still, you should keep receipts and records of expenses not reimbursed by your company.
Always be on the lookout for changes regarding applicable deductions on your annual income to lower your taxes. Make sure to review IRS guidelines thoroughly. If you have any reservations, seek help from tax practitioners.
Tax Filing Tips For Remote Workers
Remote workers who move a lot may have a more complicated tax filing season. But you can encounter less hassle if you come prepared.
Still, whenever in doubt, you can enlist the services of tax experts to help you.
What You Need To Prepare
Make sure you have all the needed paperwork for a smooth tax filing. Here are the things you need to prepare:
- A detailed list of countries, states, and cities where you performed remote work
- A breakdown of weeks or days worked in each location
- Proof of expenses and corresponding forms for applicable tax deductions
- W-2 form for remote employees
- 1099 form for independent contractors
How To File Your Taxes
You can file your taxes in two ways—through e-file or by mail. The IRS recommends online filing as this is easier and yields accurate results.
You can choose from a range of tax preparation software to aid you on this task, or you can use the IRS Free File System.
E-filing provides you with a step-by-step guide based on the information entered. That simplifies the process and won’t leave you guessing what to do next.
If you plan on filing your taxes manually, complete all required documents and double-check. Send them via certified mail and take advantage of the tracking option.
Key Takeaways
Remote work setups entail tax obligations. All parties involved should learn as much information as they can about these arrangements before entering one.
So, What Is The Tax Implication Of Working Remotely?
As an employer, you’re responsible for withholding tax payments for remote employees and not for independent contractors.
Moreover, employees outside the work state can trigger a tax nexus for income and sales and use taxes.
As a remote worker, you’re subject to varying state policies, particularly when working outside the business state. That exposes you to double taxation or possibly higher income taxes.
In most cases, you also need to file multiple tax returns for each state you work in.
With remote work and tax implications, your best weapon is knowledge of state laws combined with travel and residency documents.
