Telecommuting increase highlights cross-border taxation issues

New Hampshire’s legal challenge to Massachusetts’ temporary cross-border income tax on certain telecommuters has thrown the spotlight on state provisions for taxing non-resident income, says Fitch Ratings.

Pre-pandemic, Massachusetts taxed personal income for interstate commuters for the amount of work performed in-state. In April 2020, as pandemic-related travel restrictions curtailed interstate travel, Massachusetts amended its rule to continue taxation based on pre-pandemic commuting patterns.

Although a decision by the U.S. Supreme Court of the United States (SCOTUS) on whether to hear the case could be months away, the case highlights the fiscal stakes for states that are affected by personal income taxes (PIT) on out-of-state commuters.

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The Massachusetts regulation effectively establishes a convenience of the employer (COE) rule for personal income taxation. At least six states (Arkansas, Connecticut, Delaware, Nebraska, New York and Pennsylvania) already used COE rules to tax non-resident workers who work for an employer located in that state.

Such rules are often accompanied by tax credits for their own residents who pay tax to another state, to avoid double taxation. COE rules apply even if cross-border commuters telecommute and have remained in place during the pandemic, when the number of those working from home has significantly increased.

Cross-border income tax rules are complex and vary considerably, and the rise in remote work during the pandemic has brought COE rules, in particular, under more scrutiny. However, any outcome from a court decision or legislative action on cross-border income taxes is still uncertain.

Were there to be a change to COE rules, the revenue effect is difficult to predict, given the offsetting impacts of states’ tax provisions. For some states, the net budgetary effect would be negative, while others could stand to gain.

The risk of revenue shifts is more significant in the northeast, where convenience rules are more common given commuting patterns, and is particularly acute for New York and New Jersey.

New Jersey’s Treasury published a study in December 2020 preliminarily estimating foregone PIT revenue of $929 million to $1.1 billion from residents who normally commute to New York. The estimate was based on third-party surveys showing telecommuting affecting between 44% and 58% of the workforce in 2020. The estimates do not account for any potential netting out of New Jersey taxes imposed on New York state residents.

States have faced significant economic and budgetary challenges as a result of the pandemic, and the extent to which it triggers more permanent changes to work patterns is a key unknown going forward.

A loss of PIT and other revenues from non-resident commuters could be a further setback to states with major employment centers. Despite this, Fitch expects states would act quickly to offset any revenue losses, including through tax reciprocity agreements such as the Pennsylvania/New Jersey Reciprocal Tax Agreement.

On Jan. 25, 2021, SCOTUS asked the U.S. Solicitor General to opine on whether the court should take the case and on the merits. Four states have filed a brief supporting New Hampshire’s argument against the Massachusetts regulation (Connecticut, Hawaii, Iowa and New Jersey), while 10 states have filed a brief urging SCOTUS to take the case as a matter of original jurisdiction involving a dispute between two states. Should SCOTUS take up the case, it would likely not be heard until the court’s next term at the earliest.