Working from the beach: Minnesota residency and unintended tax consequences
December 2020/January 2021 Footnote
Editor's note: Updated November 30, 2020
Working from home during the pandemic has become the new normal. With high-speed internet and sophisticated remote access technology, people are asking — couldn’t I just work from the beach? And, if the beach happened to be in a tax-free or lower-tax state, couldn’t I save some money on state income taxes?
For Minnesota residents, however, it is not as simple as renting a condo and bringing your laptop to Florida or Arizona. To save state income tax, a Minnesota resident would have to actually move to a lower-tax state, rather than just work from that state during the pandemic. In fact, working remotely from another state can have unintended tax consequences for the individual and for his or her employer.
The pandemic has not changed the rules for when Minnesota would consider a person a resident of the state. As before, an individual is a Minnesota resident if he or she either (a) objectively spends more than half the year in Minnesota and maintains an abode in the state (“physical presence test”) or (b) subjectively remains “domiciled” in Minnesota (“domicile test”). If an individual is a Minnesota resident under either test, then that individual will pay tax on 100% of his or her income regardless of where that income was earned. In other words, if you are a Minnesota resident, you will still pay Minnesota income tax even if you spend the long Minnesota winter working from the beach in Florida or by the pool in Arizona.
However, it is possible to reduce Minnesota income tax liability if you actually move from Minnesota to another state that has a lower income tax rate or no state income tax. To accomplish a change of residency, it is not as simple as spending less than half the year in Minnesota. Spending less than half the year in Minnesota is necessary to changing residency, but it is far from sufficient. You must also show that you subjectively made another state your new home — the place to which you always intend to return whenever absent.
To prove such subjective intent, several objective factors are considered, including where you spend your time, the location of your community and family connections, the location of your employer and business interests, relative size and value of real and personal property in each location, and other contextual evidence of your intent. There is no checklist for changing residency. It is a complex factual inquiry with no guarantees or “safe harbors.”
No medical exception to Minnesota residency
Importantly, there is currently no medical exception to Minnesota residency. If you fully intend to move from Minnesota to another state, but later get “stuck” in Minnesota due to COVID-19 and inadvertently exceed half the year in the state, you will automatically be considered a Minnesota resident if you also maintain an abode (owned, rented or otherwise) in Minnesota. The Minnesota Department of Revenue’s guidance provides that the “reason” someone is in Minnesota does not affect whether that person is required to file a Minnesota income tax return.
Unintended tax consequences of working remotely
If you decide to work remotely from another state while remaining a Minnesota resident, that decision can have unintended tax consequences for you and your employer.
If you work remotely from a state that has an individual income tax, your employer may have to withhold state income tax from your wages earned in that state as a nonresident. You, in turn, would likely be required to file a nonresident return in the state from which you were working remotely.
Employer withholding and individual nonresident return filing obligations for nonresidents vary drastically by state. The majority of states require employers to withhold state income taxes from wages on the first day that a nonresident employee performs services for that employer in the state (even if just working remotely or telecommuting).1
During the pandemic, some states have issued guidance indicating that no changes to wage withholding will be required because of COVID-19. Other states are providing relief for employees temporarily working in another state because of COVID-19, but most require proof of necessity for the remote arrangement — either a mandatory work-from-home or physician’s order reflecting an inability to leave the state.
An employee working remotely (whether as a resident or a nonresident) from a state in which his or her employer has not historically had nexus likely creates nexus in that state for the employer for sales and use taxes, corporate income or franchise taxes, gross receipts taxes, and other state and local taxes. Many states currently have FAQs or other guidance that provide exceptions from nexus for employees who are “temporarily telecommuting” from those states due to COVID-19.
However, the scope, duration and application of these exceptions is unclear. Some states only except telecommuters from creating nexus if the remote work is due to “matters of safety and public health.” The implication is that if you choose to work remotely, you may be creating new state tax compliance burdens for your employer.
Risk of multiple taxation
Ultimately, if you choose to work remotely and remain a Minnesota resident, keep in mind that Minnesota will still tax 100% of your income. Thus, if you are working remotely from another state with an income tax, you may be subject to tax both in Minnesota (as a resident) and in the other state (as a nonresident). Minnesota should give a credit for taxes you pay to the other state as a nonresident to prevent multiple taxation. But the credit can get complicated. Accordingly, working remotely from a lower-tax state does not actually save you tax, it just allocates some tax away from Minnesota to the other state.
Consider a beach virtual background
Although working from the beach in Florida or by the pool in Arizona may seem like a great idea this winter, the tax implications of doing so should be fully analyzed before you pack the car or buy a plane ticket. If you are considering changing your residency from Minnesota to another state or remaining a Minnesota resident and just working from another state, you should make the decision carefully and in consultation with a tax attorney.
Masha M. Yevzelman, Esq., chairs the tax disputes and litigation practice at Fredrikson & Byron, P.A. Masha represents public and private companies, trusts, estates and high-net-worth individuals in complex tax disputes. Masha handles all stages of tax controversies, including voluntary disclosures, audits, administrates appeals, tax court, district court and appellate litigation. You may reach her at 612-492-7410 or email@example.com.