More people than ever are working remotely. It’s creating headaches for CPAs, accountants, and professional services firms in the form of residency audits.
Residency audit triggers include, but are not limited to:
- Moving to low or no-income-tax states.
- Purchasing and traveling between multiple permanent abodes.
- Moving shortly before selling a business.
- Moving shortly before selling a large amount of stock or other assets that result in capital gain.
More taxpayers have changed residencies while maintaining ties to their former state homes, so high-tax states have begun looking hard at the tax-dodging trend. For example, high-income earners and retirees are increasingly leaving high-tax states like New York and California for states like Florida and Texas. New York now conducts thousands of residency audits yearly, and from 2010 to 2017 recouped about $1 billion in taxes.
With the remote work revolution underway, how do residency audits affect remote workers working in different states? It’s an important question that every professional CPA and accountant needs to understand.
Surprise state taxes for remote workers
An American Institute of CPAs poll found that seven out of ten people (2,053 total polled) were unaware that working remotely in other states could affect the amount of state taxes they owe. COVID-19 has rearranged the work location landscape like never before. It unearthed some tax laws not many people knew existed, aside from tax professionals.
Every state has its laws about telecommuting. As many as three out of four workers have worked remotely across state lines during the pandemic. Because of how the tax code is written, a taxpayer who works in one location but resides in a different state could have to pay taxes in both states. A tax double whammy.
Remote work residency audit solutions
Some states have come up with solutions to mitigate the effect of the double-taxation issue. Maryland, Pennsylvania, Virginia, and West Virginia have reciprocity agreements with their neighbors to avoid taking worker income twice. Other states like Connecticut offer a credit to offset the income taxes workers’ pay in different states.
Arkansas, Connecticut, Delaware, Massachusetts, Nebraska, New York, and Pennsylvania follow the “convenience of the employer” rule. This rule taxes telecommuters based on where their employer’s office is located.
Despite the various solutions, it’s vital to remember different states have different rules for filing. For example, employers in Arizona must withhold state taxes if the employee has been residing in the state for more than 60 days. At the same time, in New York, employees who work even one day must file a return.
How can you help clients?
If you have a client who has moved, you might need to help them with a residency audit, especially if they’ve moved from a high tax state to a low or no-tax state. During a residency audit, your client is faced with the burden of proof. You can let your client know the type of questions that are typically asked during a residency audit. Common questions auditors ask include:
- Have you obtained a homestead exemption in one state?
- In which state do you support your spouse and children?
- In what state does your spouse live, and where do your children attend school?
- In which state are you registered to drive and vote?
- What state do you file taxes, and maintain financial connections such as banking or safe deposit boxes?
Some additional items you can do for clients also include:
- Offering nexus or residency and domicile studies.
- If the client is audited, consider an engagement letter for this service.
- Document conversations with clients who may have residency challenges.
Protect your firm from the unexpected.
Sometimes clients don’t tell you what you need to know until it’s too late. Instead of taking responsibility for their failure to communicate, they often pursue litigation and sue. Keep up with clients and continue to ask them about residency to be unaware of when it’s time for an audit or tax season.
Need more info? McGowanPRO is the leading independent agency specializing in Accountants Professional Liability Insurance (Errors & Omissions).