The sourcing of wages has become a major concern for non-resident employees of New York businesses given the number of them now seeking to telecommute at least on a part-time basis. New York’s “convenience of the employer” rule (the “Rule”) is targeted directly at such situations, and can operate as a trap for the unwary in many cases. Most states consider wages earned while working within their borders as theirs to tax. However, because the Rule seeks to tax the wages of non-resident employees flowing from services they perform outside of the state at their home offices, such wages become subject to the risk of double state taxation.
What Is the Rule?
New York, like all states that impose an income tax, taxes its residents on all of their worldwide income. Non-residents, however, are only taxed on that portion of their income that is derived from New York sources. Non-residents who commute to New York for work must pay income tax to the state on the wages that they earn while working in New York. The Rule acts as a check on a non-resident’s ability to limit their New York taxes by working from home.
Under the terms of the Rule, if a non-resident employee performs services for his employer both within and without New York, the percentage of his wages subject to tax by the state is equal to the percentage of total annual working days that he worked in New York. Pursuant to New York Tax Regulation Section 132.18 (a), which sets forth the Rule, days worked from home are treated as New York work days unless the non-resident employee worked outside the state by necessity, not as a matter of convenience.
Under the strict technical format of the Rule, the “necessity” requirement could only be satisfied if non-residents could demonstrate that their jobs, by their very features, could not be performed within New York. Because of the somewhat difficult burden that presented, the opinions arising in this area often lent themselves to seemingly baffling results.
For example, in Matter of Annitto, TSB-A-96(10)I (N.Y.S. Dept. of Tax’n and Finance, Advisory Opinion, 12/27/96) the taxpayer’s New York employer eliminated his office space in an effort to reduce rental costs. The taxpayer’s employer provided him with a computer and a dedicated telephone line so that he could work from his Connecticut residence. Even though the taxpayer no longer had an office in New York, the Department of Taxation and Finance (the “Department”) deemed all of his work days as having been spent in New York.
Possibly as a result of the public outcry over the Rule, the Department issued a Technical Services Bureau Memorandum (TSB-M-06(5)I), in 2006, in which it set forth a modified interpretation of the Rule. Under the terms of the modified Rule, which are effective for tax years starting after 2005, and applicable to non-resident employees whose assigned or primary offices (the office from which they are supervised) are in New York, any “normal work day” spent at a home office will be treated as a day worked outside New York if the respective taxpayer’s home office qualifies as a “bona fide employer office.”
A “normal working day” is considered any day on which the taxpayer performs the usual duties of his or her job. Reading professional journals, as well as responding to occasional telephone calls and e-mails, is not considered to be performing the usual duties of a position. Any day spent at home that is not a normal work day is considered to be a nonworking day and is not considered in determining the percentage of the taxpayer’s wages to be sourced to New York.
In order to be eligible for the relief provided by the modified Rule, a taxpayer must demonstrate that their home office constitutes a “bona fide employer office.” To this end, the Technical Services Bureau Memorandum (TSB-M) sets forth a series of ranked factors that are considered in determining whether a taxpayer’s home office fulfills the requirement. The factors are segregated into three groups: (1) the primary factor, (2) the secondary factors, and (3) certain other factors. A taxpayer’s home office will be deemed a bona fide employer office if it meets either: (1) the primary factor, or (2) at least four out of the six secondary factors and three out of ten of the other factors.
The primary factor requires that a home office contain or be close to specialized facilities. An example given in the TSB-M involves a nonresident employee whose duties require the use of a test track to test automobiles who has a test track located near his home, but no such track located near his employer’s offices in New York City.
If the primary factor is not satisfied, a nonresident employee’s home office can still meet the modified Rule’s requirements if the employee can demonstrate that the office meets at least four of the six secondary factors and three of the other factors.
The secondary factors are set forth below.
- The home office is a requirement or condition of employment.
- The employer has a bona fide business purpose for the employee’s home office location. An example of such a purpose would involve an engineer working on several projects for an employer, which projects are located in the employee’s home state, when the proximity of the engineer to the projects is important to meet project deadlines.
- The employee performs some of the core duties of employment at the home office. For example, the core duties of a stock broker include the purchase and sale of stock.
- The employee meets or deals with clients, patients, or customers on a regular and continuous basis at the home office.
- The employer fails to provide the employee with regular work accommodations at its regular place of business.
- The employer reimburses the employee for all of the home office expenses (e.g., utilities, insurance), or pays the employee a fair rental value for the home office, and the employer furnishes or reimburses the employee for substantially all of the supplies and equipment used by the employee. In this context, the term “substantially all of the expenses” is defined as at least 80% of them.
The other factors include:
- The employer maintains a separate telephone line and listing for the home office.
- The employee’s home office address and telephone number are listed on the business letterhead and/or business cards of the employer.
- The employee’s home office is separate and apart from the living area and is used exclusively for business purposes.
- The employer’s business is selling products wholesale or retail and the employee keeps an inventory of the products or product samples in the home office for use in the employer’s business.
- Business records of the employer are stored at the employee’s home office.
- The home office location has a sign indicating a place of business of the employer.
- Advertising for the employer shows the employee’s home office as one of the employer’s places of business.
- The home office is covered by a business insurance policy or by a business rider to the employee’s homeowner insurance policy.
- The employee is entitled to and actually claims a deduction for home office expenses for federal income tax purposes.
- The employee is not an officer of the company.
The modified Rule still imposes a heavy burden on telecommuters to avoid New York taxation with respect to the days they work at home, but does provide them with some guidance regarding what is needed to carry that burden.
Only a very limited number of states impose the Convenience of the Employer Rule, New York being one of them. Non-resident employees of New York businesses need to be cognizant of the risks imposed by the parameters of the Rule before they decide whether telecommuting will work for them. Possible double taxation should not be taken lightly.
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