The “convenience of the employer” rule for sourcing income to a particular state is anything but convenient for tri-state taxpayers. Most states that levy an income tax look to where an employee’s work is performed in determining whether their income is taxable in that state. For example, if an employee physically works in Colorado, income on wages paid to that employee would be subject to Colorado income tax, regardless of where the employer is located. States that employ the convenience of the employer rule—most famously, New York—do things differently, however. Instead of looking to where an employee physically works, these states instead ask where the employer is based, not the physical location where the work is performed. Thus, income performed for New York–based employers is subject to New York state income tax, regardless of the employee’s physical location, unless the employee can prove that the employee’s presence in another state was a necessity of the job and not simply for the employee’s convenience. In a post-pandemic remote work environment, this income-sourcing rule has huge consequences. Further complicating matters, given the particularities of state laws for resident credits (i.e., tax credits afforded to state residents to offset taxes paid to other states), these employees may be subject to dual state income taxation, owing taxes to both the state utilizing the convenience of the employer rule and the state where the work is physically performed.

Thank you for reading this post, don't forget to subscribe!

New York and Its Neighbors

New York’s application of the convenience of the employer rule has resulted in substantial animosity from taxpayers in neighboring states, particularly Connecticut, which is home to thousands of New York City commuters. Connecticut, historically, did not allow a resident credit for taxes paid on wages physically performed in Connecticut but for New York employers. As such, any individual who remotely worked from Connecticut for a New York–based employer was required to pay state income tax to both Connecticut and New York without receiving an offsetting credit from either state for taxes paid to the other. This resulted from the language of Connecticut’s resident credit, which only provides a credit for income sourced to another state under Connecticut’s income sourcing rule (Conn. Gen. Stat. Ann. section 12-704). Until 2019, Connecticut’s income sourcing statute looked solely to an employee’s physical location; so, until 2019, if an employee physically worked in Connecticut (out of convenience, but not necessity) for a New York–based employer, they would be liable for state income taxes to both states, as New York considered such wages to be New York–sourced income under its convenience of the employer rule and Connecticut considered them to be Connecticut-sourced income under its traditional location of the services standard. Moreover, because under Connecticut sourcing rules, such wages were not New York–based income—even though they were under New York law—Connecticut denied a resident credit to offset taxes paid to New York.

In 2019, presumably in retaliation for New York’s convenience of the employer rule, Connecticut amended its income-sourcing statute to include the following provision: “for purposes of determining the compensation derived from or connected with sources within this state, a nonresident natural person shall include income from days worked outside this state for such person’s convenience if such person’s state of domicile uses a similar test” [Conn. Gen. Stat. Ann. section 12-711(b)(2)(C)]. The immediate effect of this amendment was to impose Connecticut state income tax against those individuals who are domiciled and working remotely in New York (or another state employing the convenience of the employer rule) for a Connecticut-based employer. Although the number of Connecticut residents remotely working for New York-based employers likely dwarfs the number of New York residents remotely working for Connecticut-based employers, this amendment nonetheless attempts to give New York a taste of its own medicine.

The second—and perhaps more important—effect of Connecticut’s update to its income-sourcing statute was to extend the resident credit for taxes paid to other states under a convenience of the employer rule. Because Connecticut now recognizes certain income as being sourced under a convenience of the employer rule, taxes paid to other states under such regimes may be eligible for the resident credit. Beginning in 2019, the official instructions for Connecticut’s state income tax return assert that Connecticut residents who work remotely (at their convenience) for New York–based employers are permitted to claim a credit on their Connecticut income tax return for income taxes paid to New York State [see 2022 Form CT-1040 Return Instructions, https://bit.ly/4258yJb, and Rute Pinho, “Convenience of the Employer Rule,” Connecticut Office of Legislative Research (Jan. 15, 2021), https://www.cga.ct.gov/2021/rpt/pdf/2021-R-0008.pdf].

Connecticut’s move, however, did not fully solve the issue of double taxation for certain tri-state individuals. Notably, New York residents who may occasionally work remotely in Connecticut (perhaps from a second home) for a New York–based employer get no relief. This illustrates that Connecticut’s reciprocal income-sourcing scheme is not as comprehensive as it may seem at first blush.

Even with the 2019 amendment to its income-sourcing statute, Connecticut continues to tax, without exception, income earned by nonresidents that physically work in Connecticut for “more than 15 days during a taxable year.” Specifically, “all compensation the employee receives for the rendering of all personal services in this state during the taxable year shall constitute income derived from sources within this state during the taxable year” [Conn. Gen. Stat. Ann. section 12-711(b)(2) (A)]. The unfortunate effect of Connecticut’s sourcing statute as written, is that it does not instruct New York residents to uniformly apply the convenience of the employer test in sourcing their income; rather, under a plain reading, it requires New York residents (and other residents of convenience of the employer states) to “include” as Connecticut income any remote wages that are paid by a Connecticut-based employer, while simultaneously maintaining that wages for work physically performed within its borders (regardless of the employee’s state of residency and the location of the employer) is also Connecticut-source income.

Connecticut’s sourcing scheme taxes identical work performed within its borders differently based upon the residency of the taxpayer. This impedes interstate commerce by encouraging individuals to become Connecticut residents at New York’s expense.

This position represents Connecticut “having its cake and eating it too”—it applies one sourcing test for New York residents living and physically working outside of Connecticut (the convenience of the employer rule), but a separate “location of the services” test for New York residents working remotely within its physical borders. New York residents employed by New York employers, but who work remotely in Connecticut, cannot claim a resident credit against their New York taxes, as New York considers this income to be New York–source under its convenience of the employer rule and restricts its resident credit to taxes paid on income not sourced to New York. And unlike their Connecticut-resident counterparts, these New York residents cannot claim a credit on their Connecticut tax return for taxes paid to New York because Connecticut restricts this credit to only those who qualify as a “resident or part-year resident” of Connecticut (Conn. Gen. Stat. Ann. section 12-704).

Constitutional Issues?

Connecticut’s income-sourcing tax regime may very well run afoul of the United States Constitution’s prohibition on laws restricting interstate commerce, particularly after the Supreme Court’s decision in Comptroller of Treasury of Maryland v. Wynne [575 U.S. 542 (2015)], which held that a state’s individual income tax laws can violate the dormant Commerce Clause. Under long-standing precedent, courts will consider whether a “tax is applied to an activity with substantial nexus with the taxing State, is fairly apportioned, does not discriminate against interstate commerce, and is fairly related to the services provided by the State” in determining whether such a tax is constitutional. In this case, Connecticut’s sourcing scheme likely violates the prong of the above test that prohibits laws that discriminate against interstate commerce. Specifically, Connecticut’s sourcing scheme taxes identical work performed within its borders differently based upon the residency of the taxpayer. A Connecticut resident can claim a credit for New York taxes paid for work physically performed within Connecticut, but a New York resident cannot. New York residents will be required to pay taxes to both states, while Connecticut residents (by virtue of the resident credit) will only be responsible for net taxes to one state. This impedes interstate commerce by encouraging individuals to become Connecticut residents at New York’s expense.

Connecticut’s statutory scheme also discriminates against interstate commerce by encouraging individuals working for Connecticut employers to live in states that do not utilize a convenience of the employer test. Consider the following scenario—a New York resident working remotely for a Connecticut-based employer will be required to pay income taxes to Connecticut, but a Colorado resident remotely employed by a Connecticut-based employer will not. Exact same work, exact same pay, exact same employer—the only difference is the taxpayer’s state of residence. Neither taxpayer is a resident of Connecticut and neither physically works in Connecticut, yet one individual will owe taxes to Connecticut while the other will not.

To remedy this situation, this author believes that Connecticut should update its statutory sourcing scheme to ensure that it treats income earned by residents of states applying a convenience of the employer rule consistently regardless of where work is physically performed. It should not apply two sourcing tests—one for nonresidents working outside Connecticut for Connecticut employers, and one for nonresidents of the same state physically working within Connecticut’s borders.

Moreover, to bring its income-sourcing rule into Constitutional compliance, Connecticut should cap the amount of tax that is owed under its reciprocal “convenience of the employer” rule to the amount of tax for which the taxpayer can claim as a resident credit in their own state of domicile. Take for example, a Pennsylvania resident working remotely in Harrisburg for a Connecticut employer. Pennsylvania utilizes a convenience of the employer sourcing rule, so under Connecticut’s reciprocity statute, wages paid to such an individual would be Connecticut-sourced income. However, Pennsylvania imposes a flat 3.07% tax on income, while Connecticut imposes a graduated income tax from 3% to 6.99%. Accordingly, the Pennsylvania resident may end up paying an effective tax rate of 5% on the income to Connecticut, but only receive a resident credit in Pennsylvania for the 3.07% that is subject to Pennsylvania’s income tax. Compare that to a Florida resident who works remotely for a Connecticut-based employer. Because Florida has no income tax, Connecticut does not reciprocally enforce its convenience of the employer rule to claim this worker’s wages as Connecticut-sourced income. As such, the Florida resident has no income tax obligations in Connecticut. In this example, the Pennsylvania employee is paying a net-additional tax of 1.93% to Connecticut because she lives in a state that utilizes the convenience of the employer rule. Connecticut is essentially imposing a tariff on this individual based on her state of residence, something it is not doing to the similarly situated Florida resident.

Cleaning up its income-sourcing regime would also shore up the legal grounds by which Connecticut affords a credit to its residents who pay taxes to New York under that state’s convenience of the employer rule. It is somewhat inconsistent for Connecticut to assert that its residents’ remote wages earned for New York–based employers is properly New York–source income (and thus eligible for the resident credit), but that an identically situated New York resident’s income is Connecticut sourced because the work is physically performed within Connecticut’s borders (unless, of course, Connecticut were to consider such income to be dually sourced, a notion that raises its own Pandora’s box of constitutional concerns). Again, Connecticut’s reciprocal convenience of the employer rule workaround is, in this author’s opinion, too cute. New York, for all the confusion and headaches that its convenience of the employer rule creates, at least applies it consistently.

A Not-So-Simple Search for Uniformity

A uniform sourcing rule for residents of states employing the convenience of the employer rule may well have been Connecticut’s intent in updating its income-sourcing statute. Indeed, the Connecticut Department of Revenue Services web-site plainly stated through 2022 that “for taxable years beginning on or after January 1, 2019, Connecticut will apply the Convenience of the Employer test in determining Connecticut-source income of residents of states that apply the same rule.” (Note that Connecticut has recently removed this language from its Department of Revenue website; the prior language is the available at https://bit.ly/3IrppPo.) If the Department of Revenue’s prior instructions mirrored the statutory language, the problem would be solved. New York residents remotely working in Connecticut for a New York employer would simply have no Connecticut-source income on which to pay taxes. Indeed, Connecticut’s current official resident credit guidance arguably gives New York residents legal footing to argue that remote wages physically performed in Connecticut are not Connecticut-sourced income. Unfortunately, Connecticut’s statutory regime is not so simply worded. In the author’s view, Connecticut should either amend its statute to make it clear that it applies only one income-sourcing rule to New York residents (the convenience of the employer rule) or provide regulatory or interpretive guidance stating as much.

To remedy this situation, this author believes that Connecticut should update its statutory sourcing scheme to ensure that it treats income earned by residents of states applying a convenience of the employer rule consistently regardless of where work is physically performed.

Stephen Josey, JD is of counsel at Kostelanetz LLP, focusing on tax controversies, white-collar criminal defense, and commercial disputes.