Understanding the Convenience of the Employer Rule

What is "Convenience of the Employer Rule"?

Introduced in 2023, the COE directly results from remote work culture. It regulates taxation for out-of-state employees in the USA. The rule states that salaries of employees who live and work outside the state in which the employer operates will be taxed according to the laws applicable in the employer state. Resident state laws now introduce credit waivers against taxes paid in other states to level the playing field. 

The more pertinent question is, why introduce the COE in the first place?

The Purpose of the Rule

In the USA, it is mandatory to deduct Federal tax, insurance, and a few other benefits as per the decree of the Federal government. As the remote work culture set in, tax deductions became complex. The primary purpose of introducing the COE rule was to prevent tax evasion by remote employees. 

The rule also facilitates employers, allowing employees to work from home to reduce investment in office space, equipment, and other resources. Employees who use their equipment and register it as home office tax deductions get a better work-life balance. The rule is essentially a win-win for all. However, not all states follow the rule.

‍Suggested Read: Taxing your Digital Nomads – A Complete Guide

What are Reciprocal Tax Agreements?

Before the introduction of the COE rule, many states had reciprocal tax agreements that allowed employees with workplaces in another state to be taxed in their resident state. The employer could not withhold tax in the state where the workplace was located. At last count in 2022, 16 states have reciprocal tax agreements. Others, as you will read below, have adopted COE.

So, are the convenience of employer rule and reciprocal tax states the same?

No. Under a tax reciprocity agreement, two or more states come together and agree not to tax employees traveling into these states for work if they are residents of the states that are party to the agreement.

The convenience rule, however, allows employers to tax employees in the state of work rather than residence.

So, the two are pretty different.

Interestingly, Connecticut is the only state to insist on reciprocal convenience – extending the convenience of employer rule only to those states that have implemented it.

States that Uphold this Rule

Before the introduction of the COE, many states taxed employees at their place of residence rather than at work. To take a completely fictitious example, a resident of New Jersey working in New York may be taxed under New Jersey laws. After the COE was introduced, the employer could deduct tax under New York laws.

Not all states are convenience tax states. At last count, the following states have adopted the convenience rule:

• Arkansas

• Connecticut

• Delaware

• Massachusetts

• Nebraska

• New York

• Pennsylvania

Of these, Massachusetts introduced the rule only temporarily during the pandemic, while Connecticut adopted the convenience of employer rule only on a reciprocal basis. Adopting the rule is still in flux, and other states may adopt it in the future, or states that have already adopted the rule may cease to do so.

One thing of note is the way Connecticut adopted the rule under the condition of reciprocity. In the past, too, many states have introduced reciprocal tax agreements.

The Importance of the Convenience of the Employer Rule

The COE was explicitly introduced to help with cross-state taxation during the pandemic and its aftermath. Therefore, the rule's significance lies in the need to manage geographically diverse teams. 

As a business owner, it is your responsibility to withhold and submit tax on behalf of your employees. However, taxation can get complex when your employees work from diverse locations, which may be in other states or countries. The COE eases this considerably, primarily when employees reside in convenience tax states.

The Convenience of the Employer Test (Applying the Convenience of the Employer Rule)

Under Publication 587, Business Use of Your Home, the IRS clearly outlines the Convenience of the Employer test. While the rule is simple, its application is a little complex. The IRS states that the term Convenience of the Employer means precisely that – the convenience of the employer and not that of the employee.

Consider this, John works for an employer who has provided a workplace and all the necessary equipment for its employees. However, John lives out of state and has an office, so he prefers to work from home rather than travel.

Technically, John should claim reimbursement for all expenses. However, he cannot do so under the convenience of the employer rule. It is because he chose to work from home for his convenience and not the employer's. Since the employer is not accommodated or does not require convenience, the rule does not apply.

Factors Determining the Convenience of the Employer

Of course, the factors that determine the test vary from state to state, but as a general rule, if the arrangement does not accommodate or facilitate the employer, the rule does not apply.

With that said, here’s a generic list of common factors that determine the applicability of the test:

• That the employee works out of a home office with exceptional facilities and/or equipment required for the job, which the employer cannot provide.

• The employer has a clear purpose for using the employee’s home office

• The home office performs duties delegated by the employer for his convenience.

• The employee regularly utilizes the home office for the above purpose.

• The employer cannot or does not provide the employee with the necessary workspace and/or equipment.

• The employer compensates the employee for use of his home office.

In addition to the above, the test also mandates the following:

• An independent phone line.

• The employee's home office address must be listed on the employer’s business card or letterhead.

• Inventory, if any, is maintained in the home office.

• Employer’s business records are maintained in the home office.

• The home office location bears a sign that it is a place of business.

• Marketing materials show the employees' home office as a place of business.

• The home office is insured.

• The employee is not an officer of the company.

• The employee claims tax deductions.

Individual states may include a few other factors.

Challenges of the Convenience of the Employer Rule

Let’s say you live in New Jersey, and your workplace is in New York. In this situation, you’d pay taxes to New York and New Jersey on the same wage! And that’s not all. The rule has been challenged in court as going against the constitutional rights and several existing laws and regulations.

The challenges against the rule include:

• It goes against the principle of dormant commerce that prohibits states from excessively burdening interstate commerce.
• It violates the contention of due process, which requires a taxpayer to have a specific minimum contact with a state before the state can impose tax.
• The rule allows states to tax the taxpayer and the business for the same income, resulting in excess tax payment.
• COE has not factored in the pervasive change in work culture – of remote working or a digital nomad lifestyle.

The COE rule was introduced in response to the restrictions imposed by the pandemic, and the federal government failed to consider its full impact.

With remote work still soaring and people working across state borders, the complexities are unlikely to reduce anytime soon. The rule may evolve along with the evolving work culture.

Manage Your Global Team with Skuad

As more and more employers adopt the teleworking model, companies need to comply with the convenience of the employer rule across different states. But, compliance with local laws can be tricky and time-consuming, especially when working with globally distributed teams. 

With Skuad’s unified platform, you can hire, onboard, and pay employees and contractors in over 160 countries. We ensure that you stay 100% compliant with all local employment and labor laws in the country you hire. Speak to our compliance experts to learn more.

FAQs

1. What is New York's convenience of the employer rule?

The convenience of the employer rule in New York states that out-of-state employees who earlier commuted to work and have now switched to telecommuting will continue to be taxed under New York tax laws.

2. Which states have Convenience of the Employer Rule?

The "Convenience of the Employer" rule is primarily adopted by New York, Pennsylvania, Nebraska, Delaware, and New Jersey. This rule states that income earned by non-residents working remotely for an employer based in these states can be taxed by the state where the employer is located. This is significant for remote workers and employers, as it affects tax liabilities and payroll considerations. Both employees and employers need to consult with tax professionals to navigate these state-specific regulations effectively.