While many organizations have called for workers to return to the office, there are still three times more remote jobs than compared to 2020, with hybrid and remote work trends continuing to grow. Many employees love the flexibility created by remote work. However, those who live and work in different states (or countries) may fail to understand the complex network of state and international income tax laws. As the lead manager at the AICPA stated, “All 50 states have 50 different ideas. There’s no federal solution right now. Every state works differently.” Remote work taxes are challenging, and we hope this article aids practitioners, including CPAs and Enrolled Agents in navigating some of the most common tax issues.
A summary of remote work taxation
When an employee lives and works in the same state, they do not have any multistate tax issues because they will only file and pay income taxes in their state of residence. Conversely, when an employee lives in one state and works for an out-of-state employer, they may have multistate tax issues. How complex these issues are typically depends on whether:
- The employee’s state of residence or the employer’s location is in a state with no income tax (Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, or Wyoming)
- The employee works completely remote or works a hybrid schedule that includes time at the employer’s out-of-state location
- The employer’s state has a convenience-of-the-employer rule
- The employee’s state and employer’s state have a reciprocity agreement with each other
Table of contents
- How income tax relates to where you live and work
- Remote work taxes when a state doesn't have an income tax
- Remote work taxes when both states have an income tax
- The Convenience-of-the-Employer Rule
- Extended travel and remote work taxation
- Federal taxation of remote workers
- Taxation when working remotely in another country
- Defining 'abode' when calculating remote work taxes
- Remote work tax credits for income taxes paid abroad
Remote work taxes: How income tax relates to where you live and work
Generally, an employee’s income is taxed where they live and work. The employee’s state of residence can tax 100% of the employee’s income, though states may have different residency rules, while the employer’s state can generally only tax income the employee earns in that state. Income is typically earned in the employer’s state when an employee is physically present and working there.
Remote work taxes when one state doesn’t have an income tax
If one state does not have an income tax, the employee will generally only pay income taxes to one state. In this scenario, the tax consequences depend on whether it is the employee’s state or the employer’s state that has the income tax. For example, if someone resides in Texas but works for an employer located in Louisiana and they work 100% remotely, they will owe no state income taxes. Texas has no income tax, and the employee never earned income in Louisiana.
However, if the employee was ever physically present and working in Louisiana, the portion of their income earned in Louisiana would be subject to Louisiana income tax. Conversely, if a Louisiana resident works for a Texas employer, 100% of their income would be subject to Louisiana income tax without regard to whether the employee was ever physically present in Texas, and no income tax would ever be due to Texas.
Remote work taxes when both states have an income tax
When the employee’s state and employer’s state both have an income tax, the issues are more complex. Except as discussed below with respect to the convenience-of-the-employer rule, if an employee works 100% remote, they generally only file and pay taxes to their state of residence. However, if an employee was physically present and working in the employer’s state during the year, they must file and pay taxes to both states on the income earned while physically present in the employer’s state and on all income to their state of residence.
To alleviate double taxation in these situations, states generally provide a credit to residents who pay taxes to other states. Consequently, if taxes are higher in the employer’s state, the employee pays more taxes than if they had worked exclusively in their state of residence.
The "convenience of the employer" rule: Some states tax remote employees' income based on their employer's location unless remote work is required for the employer's business needs.
Remote work taxes and the convenience-of-the-employer rule
When the employer is located in a state with a convenience-of-the-employer rule, the employee may be required to file and pay income taxes to the employer’s state even if they were never physically present and working there. The test, which varies among states, is whether the employee is working remotely for the employee’s convenience, not because the employer requires it. If so, the employee must generally file and pay taxes to both their state and the employer’s state. Additionally, in these situations, some states may not allow a credit to offset taxes paid in the other state, resulting in double taxation.
The eight states with a convenience-of-the-employer rule are:
- Arkansas
- Connecticut
- Delaware
- Massachusetts
- Nebraska
- New Jersey
- New York
- Pennsylvania
Reciprocity agreements to avoid double taxation
Luckily, some states have reciprocity agreements to alleviate multistate income tax issues arising from residents working in other states. Under these agreements, states generally agree that an employee only files and owes income tax to their state of residence. There are currently 30 reciprocity agreements among 16 states and the District of Columbia:
- Illinois
- Indiana
- Iowa
- Kentucky
- Maryland
- Minnesota
- Michigan
- Montana
- New Jersey
- North Dakota
- Ohio
- Pennsylvania
- Virginia
- West Virginia
- Wisconsin
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Factoring extended travel into taxes for remote workers
As an additional precaution, practitioners should also inquire about their remotely working clients’ travel during the year. If an employee traveled to another state(s) that imposes an income tax and worked there during the year, additional filing and payment obligations may exist in that state(s).
Extended stays in another state may cause unexpected issues because many states have rules that establish residency when an employee is in a state for more than half the year. Under these rules, not only are the employee’s wages subject to income tax but potentially any other types of income (e.g., investment income) could be taxable.
Remote work taxes and federal taxation
For federal income tax purposes, an employee does not have many tax benefits because the Tax Cut and Jobs Act of 2017 eliminated an employee’s ability to deduct unreimbursed business expenses (formerly a miscellaneous itemized deduction) and the home office deduction. However, if the individual is classified as an independent contractor, they can deduct their business expenses and may qualify for the home office deduction.
Taxation when working remotely in another country
When an employee or independent contractor, who is a US citizen, works remotely in another country, the tax issues become complex because each country has its own tax code. Under the 183-day rule used by most countries, an employee is generally considered a tax resident if they physically reside in a country for at least 183 days during the year.
However, some countries have even lower thresholds that trigger tax residency. Accordingly, a US citizen living and working abroad may be required to file and pay income taxes to the foreign country. To aid in this determination, tax practitioners need to determine if the foreign country has a tax treaty in effect with the US by referring to the IRS website. Such tax treaties help determine jurisdiction for income tax purposes and alleviate (or eliminate) double taxation. These agreements generally also contain provisions to resolve conflicting residency claims.
Foreign earned income exclusion
Even if a US-citizen employee lives outside the US the entire year, they are still required to file and pay US income taxes on their worldwide income. However, the foreign earned income exclusion (hereafter, exclusion) can alleviate double taxation issues by excluding up to $126,500 of foreign earned income from US taxation. This is the 2024 amount, which is adjusted annually for inflation). For purposes of the exclusion, foreign earned income is earned income, generally wages and business income attributable to services performed by a taxpayer outside the US.
To qualify for the exclusion, an employee must satisfy the following:
- They must either meet the requirements of the bona fide residence test or physical presence test, and
- They must have a tax home in the foreign country.
By law, US government employees working abroad will generally not qualify for the exclusion, but subcontractors (and their employees) providing support for US armed forces may qualify if they meet the requirements mentioned previously.
The bona fide residence test
Under the bona fide residence test, an employee must intend to be a bona fide resident of the foreign country for an uninterrupted period that includes an entire taxable year. An employee’s intention, purpose/nature of the trip, and length of stay are important factors required to satisfy the test, just merely living in the country will not qualify. Moreover, employees can leave the foreign country for brief trips (e.g., vacation) and still qualify, but they must always intend to return.
The physical presence test
Under the physical presence test, an employee must be physically present in the foreign country (or countries) for at least 330 full days in a 12-month period, which does not have to coincide with the employee’s tax year. A full day means the 24-hour period starting at midnight and does not include time flying over international waters.
An employee does not have to be in the country solely for business, but days for brief trips do not generally qualify. Unlike the bona fide residence test, an employee’s intention and purpose/nature of the trip are irrelevant—only full days of physical presence are necessary.
Having a tax home to qualify for exclusion
If an employee meets either the bona fide residence test or physical presence test, they must also have a tax home in the foreign country to qualify for the exclusion. An employee’s tax home is generally considered to be the location of their regular or principal place of employment. However, a taxpayer cannot have a tax home in a foreign country for any period their abode is in the US. An employee whose abode is in the US cannot establish a tax home in the foreign country, even if their principal place of employment is in the foreign country.
Defining ‘abode’ when calculating remote work taxes
While abode is not defined in the Internal Revenue Code (IRC) or regulations, the US Tax Court has held that it generally means the country in which the employee has the strongest economic, familial, and personal ties. An employee working abroad will always have some connections to the foreign country, but their abode will remain in the US if their ties to the US are stronger.
For example, In Leuenberger v. Commissioner (T.C. Summary Opinion 2018-52), the US Tax Court determined that the taxpayer’s abode remained in the US because he owned and managed investment properties in the US, owned and registered vehicles in the US, maintained financial accounts in the US, and his family resided in the US. Moreover, the taxpayer’s only proven connection to the foreign country was the location of his employment. Consequently, the taxpayer did not qualify for the exclusion because he never established a tax home in the foreign country as his economic, familial, and personal ties to the US were stronger.
Because of the strict abode requirements, tax practitioners should closely evaluate each client’s facts and circumstances because it is likely that many employees will not have a tax home abroad. It is very common for taxpayers to think they qualify for the exclusion based solely on meeting the 330 -day requirement of the physical presence test. This alone will not qualify an employee for the exclusion.
Remote work tax credits for income taxes paid abroad
Lastly, a US citizen can take a credit for income taxes paid abroad. This credit can be taken in lieu of the exclusion and provides a planning opportunity. However, if an employee elects to take the credit, all foreign earned income must be included in their total income.
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