INSIGHT ARTICLE |
Authored by RSM US LLP
The COVID-19 pandemic has dramatically changed the “work-from-home” trend in the US. Prior to the pandemic, typically only high-level employees had the option to work remotely. Now, a much larger percentage of employees are working from home, facilitated by new technology. Although governmental stay-at-home orders have ended and employees can return to their workplaces, many employees prefer to continue working from their homes. Thus, employers are now wrestling with various iterations of work-from-home options and the related compensation and tax issues.
Remote worker policies
Employers have a wide range of remote worker possibilities to consider. Some larger employers have announced that they want their employees back in the office most of the time, so they will have very few remote workers. A few companies have moved towards being primarily remote, even giving up most of their office space. Many other companies are keeping their office space for now, with the intent of deciding at a later date, such as upon renewal of their lease, whether they will reduce their real estate footprint. Other companies have decided that all employees in good standing can choose to be fully remote and work from anywhere within the US.
Employers need to consider both the advantages and disadvantages of offering work-from-home options. Advantages include providing employees with the flexibility that they want, and being able to hire from a wider pool of candidates who might not be willing to move to the company location. In addition, there may be significant, long-term cost savings to a company if many of its employees work remotely. On the other hand, companies are concerned about losing vital interactions between team members, and reduced training and support of new employees when more experienced employees are working remotely.
To accommodate remote worker variations, employers may classify their employees into the following groups:
- Non-remote workers who return to the employer’s office and do not typically work from their homes on an on-going basis.
- Fully-remote workers who choose to work from their homes almost all of the time. These employees seldom have duties that must be performed in the employer’s office. These employees typically give up their office or cubicle space in the employer’s office and their homes become their designated primary workplace. In some cases, employers are requiring employees to work from home on a go-forward basis.
- Hybrid-remote workers who choose (or are required) to split their work time between their home and their employer’s office. These employees may decide on an individual basis how much time they work in each location. Hybrid-remote workers may or may not have a designated workspace in their employer’s office. Depending on the circumstances, the primary workplace for some of these workers may be the employer’s office and for others it could be the employee’s home; therefore, subcategories of hybrid-remote workers may be needed to account for these differences.
Companies will need to balance the needs of employees who are non-remote workers with those who are fully- or hybrid-remote workers. Furthermore, as discussed below, the facts of an employee’s arrangement will drive the tax treatment. Thus, companies will need to define the line between a fully-remote worker and a hybrid-remote worker, and possibly between subcategories of hybrid-remote workers. Company policies will need to be established for each group taking into consideration the related federal and state tax and legal issues.
Compensating remote workers for services
Many employers have maintained their same compensation structures during the COVID-19 pandemic that were in place before. Frequently, a factor in determining an employee’s compensation is the cost of living in the area where the employer’s office is located. Now employers are grappling with the question of whether an employee’s compensation should be adjusted when the employee moves from a high-cost area to a lower-cost one and will be working remotely. For example, if an employee working in the employer’s New York City office becomes a fully-remote worker and moves to Pennsylvania, should the employee get a reduction in compensation?
Although a few employers may implement pay reductions based on location, many others will not. However, an employee’s future pay raises might be smaller to take into account the employee’s new location and lower cost of living. Therefore, in the long run, having remote workers in lower-cost areas may generate compensation cost savings to an employer.
Another compensation issue affecting employees who are fully- or hybrid-remote workers is the withholding of state and local income tax from their wages. Withholding rules are complex and vary greatly by state and locale. Employers will need to know where their remote workers are located, and which state and local income tax withholding rules apply to each remote worker. In addition, employers that have remote workers in states where they do not have business operations may now have nexus in those states and be required to report revenue and pay various taxes to those states. For more information on these topics, see our articles Never going back and State income tax considerations for remote employees during COVID-19.
Compensating remote workers for business expenses
When implementing work-from-home policies, employers should consider the tax aspects of paying or reimbursing business expenses for remote workers. Common expenses include travel, office equipment and supplies, and phone and internet services.
In general, the tax law allows employers to pay various business expenses for employees without creating taxable income to those employees. If employees pay these expenses themselves, they may be able to receive tax-free reimbursements from their employers. In the past, business expenses not reimbursed by an employer potentially were deductible by employees as miscellaneous itemized deductions on their federal income tax returns; however, that is no longer the case after 2017 due to the Tax Cuts and Jobs Act. Therefore, employees are now more likely to expect their employers to cover the cost of business expenses.
Companies also need to be aware that several states require employers to pay or reimburse employees’ work-related expenses, including costs incurred due to working from home. These requirements vary by state. Our understanding is that the following states currently have some type of requirement for certain employees: California, Illinois, Iowa, Massachusetts, Minnesota, Montana, New Hampshire, New York, Pennsylvania, and the District of Columbia. Employers are advised to consult with legal counsel on this issue.
Employers often ask about the tax treatment of costs that they pay for an employee to travel between the employee’s home (residence) and the employer’s office. Depending on the circumstances, these travel expenses could be taxable or tax-free to the employee and nondeductible or deductible to the employer. A critical factor in this determination is whether the employee’s “tax home” is the employer’s office or the employee’s home.
Tax home is the employer’s office. In general, if the employee’s tax home is the employer’s office, then employer-paid travel between the employee’s home and the employer’s office is taxable compensation to the employee as a personal commuting expense and subject to payroll taxes. In addition, due to section 274(l) of the Tax Cuts and Jobs Act, certain commuting expenses are not deductible by the employer even though the expense is included in the employee’s taxable compensation.
A number of courts, including the US Supreme Court, have ruled that an employer’s office was the employee’s tax home if the employee was hired with the expectation that the employee would work in the employer’s office on a regular basis and the employer provided an office or cubicle for that employee.
…for travel purposes, an employee’s home can often be the tax home even if the employee does not have a separate area used exclusively for the employer’s work.
When applying these rules to employees who are hired as (or become) hybrid-remote workers, some employers conclude that the worker’s tax home is the employer’s office because the employer expects the worker to be there regularly even though it does not provide a specific office or cubicle for the exclusive use of that worker. The employer may use a shared space or “hoteling” system, but does provide workspace on a routine and regular basis so that the remote worker can generally assume workspace will be available upon arrival at the employer’s office.
If the employer’s office is a remote worker’s tax home, this worker would have taxable income if the employer pays for the worker’s travel expenses to its office, regardless of whether the travel is a 20-minute drive or a three-hour plane ride from the worker’s home.
Tax home is the employee’s home. Generally, if an employee’s tax home is the employee’s home, then employer-paid travel between the employee’s home and the employer’s office is tax-free to the employee and deductible by the employer as a business travel expense. An employee’s home will likely be the employee’s tax home if the employee is not expected to work in the employer’s office on a regular basis and is not provided an office or cubicle there.
To facilitate making an employee’s home the tax home, some companies will clearly state in writing that an employee’s “post of duty” is the employee’s home and the company will not encourage or expect the employee to work in its office on a regular basis. Other employers may limit the amount of time that an employee can spend in the employer’s office or the number of times per year the employee can travel to the office or be reimbursed for such travel.
Note, for travel purposes, an employee’s home can often be the tax home even if the employee does not have a separate area used exclusively for the employer’s work. For example, an employee’s home could still qualify as the tax home even if the employee uses the dining room for both meals and performing work for the employer.
For hybrid-remote workers who spend a smaller amount of time working from their homes compared to fully-remote workers, the tax home determination is more complex.
Given that companies have discretion on how they define fully-remote worker versus hybrid-remote worker, employers need to give consideration to this tax home issue when establishing policies. Some companies may define a fully-remote worker as an employee who works from home 90% of the time during a year. Other companies may be comfortable applying a lower percentage, such as 70%. Still other companies may define a fully-remote worker as an employee who works no more than three or four days a month in the employer’s office. In all of these cases, companies may decide that a fully-remote worker’s tax home is the employee’s home. This decision should be documented in the company’s policies and be respected in practice. Note that defining an employee as a fully-remote worker when the employee is expected to work in the employer’s office on a fairly regular basis (more than a few weeks a year) can raise withholding and payroll tax risks.
For hybrid-remote workers who spend a smaller amount of time working from their homes compared to fully-remote workers, the tax home determination is more complex. Employers should take all facts and circumstances into account when making this decision and establishing policies. Some employers may need to have subcategories of hybrid-remote workers to account for these differences as the employee’s home may be the tax home for some and the employer’s office may be the tax home for others. Many companies are treating hybrid-remote workers as having a tax home at the employer’s office, but if a company has subcategories of hybrid-remote workers it will need to determine which specific employees have a tax home at the employer’s office.
Other situations. There are other tax rules that apply if a worker has a primary and secondary place of business due to the employer needing the employee to work in two different geographic locations. In the IRS guidance, the two different locations are both considered employer places of business. While it may be possible to argue that an employee’s home could be either a primary or secondary business location of the employer, the facts would have to support this position. These rules would only come into play if a remote worker regularly works from home and from the employer’s office because the employer has a specific need for the employee to work in each of those geographic locations. This is not the same as an employer allowing an employee to choose to work from home.
In some cases, an employee does not have a regular workplace and is treated as itinerant for tax home purposes. In these situations, unfavorable tax consequences could arise.
For more information about employer-paid travel, see our article Tax issues arise when employers pay employee business travel expenses.
Office equipment and supplies
Employers need to consider how to provide office equipment and supplies to remote workers on an on-going basis. Office equipment may include computers, monitors, printers and perhaps even furniture (such as a desk or chair). Some employers have remote workers pick up certain items from the employer’s office whereas others have items delivered to the employees’ homes or allow employees to purchase the items themselves. Some employers specify the make or models of equipment that can be purchased by employees while others set limits on the maximum that can be spent on such equipment.
It is common for employers to provide computers and monitors to remote workers and less common for them to provide printers or furniture. Office supplies provided may include printer cartridges and paper along with pens, pencils and other items. The types of equipment and supplies that an employer provides to a remote worker may depend on whether that employee is a fully-remote worker or a hybrid-remote worker.
Companies can either pay vendors directly for office equipment and supplies that they furnish to their employees or reimburse the employees for these costs if the employees purchase these items themselves. The tax consequences to the employees depend on factors such as whether the items, such as equipment, must be returned to the employer if the employee terminates employment, and whether the employees must provide written substantiation of items they purchase themselves. In some cases, office equipment and supplies can be provided to remote workers on a tax-free basis.
Phone and internet service
Sometimes employers decide to pay for a portion of a remote worker’s phone and/or internet service, and may set different policies for fully-remote workers versus hybrid-remote workers.
To date, the IRS has only issued specific guidance regarding the tax treatment of cell phones. Under these rules, if the employer determines that an employee needs the cell phone for work, the employer can consider any personal use of the cell phone as de minimis. Therefore, an employer can provide cell phones to employees or reimburse employees for cell phone expenses on a tax-free basis with appropriate substantiation of the expenses. With regard to other phone or internet services, companies may be able to provide tax-free reimbursements to employees for the portion of these expenses attributable to business use.
Many companies are at the early stages of determining their remote worker strategies and policies. It is important that these policies state the company’s rules, definitions of terms and allocation of responsibilities between the company and its employees. The policies should also be clearly communicated to employees and their managers. Consideration should be given to the state and federal tax issues regarding remote workers, including the payment of compensation and business expenses. Employers should consult with legal counsel and tax professionals on these matters.
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This article was written by Karen Field, Jill Harris and originally appeared on 2021-11-03.
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