History is replete with examples of leaders who chose to battle, or who were forced into defending against, enemies on two fronts. Rarely did it end well for the combatant that occupied the middle ground.
In a sense, New York has stumbled into a similar situation with two of its neighbors, New Jersey to the west and Connecticut to the east.[i] The three states,[ii] which comprise the Tri-State Area centered on New York City, are openly competing with one another for badly needed tax dollars.
Convenience of the Employer
The impetus for this fiscal feud arises from New York’s “convenience of the employer” rule, which the State applies to tax the earnings of New Jersey and Connecticut residents who are employed by a New York business but may also perform services for their employer outside New York.
It has long been accepted that a State may tax a nonresident individual only with respect to income from sources within that State.[iii]
In the case of an individual who provides services within a State of which they are not a resident, the source-based limitation permits the State to tax the nonresident’s compensation only to the extent such compensation is attributable to services rendered by the nonresident within the State, which is usually determined by comparing the number of days worked by the nonresident within the State with their number of days worked outside the State. In other words, those wages earned by a nonresident employee for work performed outside a State may not be taxed by that State.
In the case of a nonresident employee who performs services for their New York employer both within and without the State, New York’s law is similar to that of other States; it provides that the nonresident’s income derived from New York sources includes that proportion of their total compensation for services rendered as an employee which the total number of working days employed within New York bears to the total number of working days employed both within and without New York.
However, any allowance claimed by the nonresident employee for days worked outside New York must be based upon “the performance of services which of necessity, as distinguished from the convenience, obligate the employee to out-of-state duties” in the service of their employer.[iv]
Historically, the application of this rule has enabled New York to collect billions of dollars in income tax on an annual basis from several hundred thousand New Jersey and Connecticut residents who commute to jobs in New York.
These commuting employees were sorely disappointed during the pandemic when, instead of relaxing its “convenience” rule, New York indicated that the days on which a nonresident telecommuted from their home outside New York – a “normal work day” – would be considered days worked in New York if the nonresident’s “assigned or primary office” was in New York, unless the nonresident’s New York employer specifically acted to establish a bona fide employer office at the nonresident employee’s non-New York “telecommuting location.”[v]
In the absence of such a bona fide employer office at the employee’s telecommuting location – say, in New Jersey or Connecticut – the nonresident employee would continue to owe New York personal income tax on income earned while telecommuting from their home in one of those States.[vi]
As explained below, New York’s stubborn adherence to its convenience rule deprived its neighbors of tax dollars during a very difficult period.
N.Y.’s Gain = N.J.’s + CT’s Loss
A Connecticut resident is subject to Connecticut income tax, and a New Jersey resident is subject to New Jersey income tax, on all of their income regardless of where the income is earned or sourced.
However, if the Connecticut resident or the New Jersey resident works in another State that imposes an income tax on compensation earned within that State – New York comes to mind – the individual is also subject to tax in the State in which they work.
That is not to say that a resident of, say, New Jersey with compensation income for services performed in New York will necessarily pay tax on such income to both New Jersey and New York.
The New Jersey resident will have to report this New York source income on a New York nonresident income tax return, and it will remit to Albany the New York income tax imposed on such income.[vii]
At the same time, the New Jersey resident will also have to report this compensation income on their New Jersey resident return. However, in determining their New Jersey resident tax liability on such income, the resident may be eligible for a credit for any income taxes paid to New York on the income. The credit reduces the resident’s New Jersey income tax liability, so they don’t pay taxes twice on the same income – once to New York as a nonresident, and once to New Jersey as a resident.
In other words, New Jersey will forego collecting tax from a resident taxpayer on income “sourced” in New York – therein lies the rub – to the extent the income was taxed by New York.
Thus, the credit has the effect of shifting tax revenue away from the New Jersey taxpayer’s State of residence and into the State (New York) in which the income was earned.[viii]
Just a few years ago, however, it looked as if this state of affairs was finally going to addressed.
New Hampshire v. Massachusetts
You may recall that, during the pandemic, Massachusetts temporarily adopted its own version of the “convenience” rule to tax nonresident employees who began telecommuting following the Commonwealth’s emergency order requiring all nonessential businesses in Massachusetts to close their physical workplaces and facilities.
According to the Commonwealth, all compensation received for services performed by a nonresident who, immediately prior to the emergency order, was an employee engaged in performing services in Massachusetts, and who began performing services from a location outside Massachusetts due to a “pandemic-related circumstance,” would continue to be treated as Massachusetts source income subject to the Commonwealth’s personal income tax.
As we know, New Hampshire reacted to its neighbor’s action by filing a lawsuit against Massachusetts in the U.S. Supreme Court claiming, among other things, that Massachusetts was infringing upon New Hampshire’s sovereignty by seeking to impose a tax upon New Hampshire residents in respect of income they earned in New Hampshire – not in Massachusetts.
The Amicus Brief
As we also know, New Jersey and Connecticut filed a “friends of the court” brief in which they (i) described their own experience with New York’s efforts to tax their residents, (ii) supported New Hampshire’s request that the Supreme Court accept the action initiated by the Granite State, and (iii) urged the Court the rule in favor of New Hampshire – and, by extension, New Jersey and Connecticut – on the merits.
This brief presented a persuasive argument against the continued application of the “convenience” rule.
Sourced Outside New York
According to the amicus brief, New York levies taxes on nonresident employees for income they earn while working at home in their New Jersey or Connecticut residences, as the case may be. The imposition of these taxes, the brief claimed, is inconsistent with the Federal Constitution because they are not fairly apportioned. According to the brief, the “central purpose” of the fair apportionment requirement is “to ensure that each State taxes only its fair share” of a tax base. A State does not tax its “fair share,” the brief asserted, when the State directly taxes the income that nonresidents generated outside the State’s borders by working from home.
In urging the Court to exercise its original jurisdiction to accept New Hampshire’s petition, the amicus brief illustrated the impact of the Massachusetts and New York tax schemes as follows: “As New Hampshire highlights, an individual who spends her day working at home in New Hampshire could be required to pay Massachusetts taxes on her entire income, even though her Home State [New Hampshire] (where she spent the entire month) levies no such tax. . . Similar rules apply . . . to the Connecticut and New Jersey residents who work most days from their Stamford or Jersey City apartments for a company based in Manhattan.”
In addition, according to the brief, the taxes paid by these nonresident taxpayers to New York have an adverse effect upon New Jersey’s and Connecticut’s finances because these States – in order to mitigate the risk of double taxation on their residents who have New York source compensation income – voluntarily provide a credit to their residents for taxes these residents have paid to New York. In doing so, New Jersey and Connecticut are sacrificing billions of dollars in tax revenue, while New York enjoys a windfall.
This is particularly troubling, the brief asserted, because New Jersey and Connecticut provide police, medical and other services to their residents working at home without collecting tax revenue. “Yet that is the Hobson’s Choice to which [New Jersey and Connecticut] are put: doubly tax residents’ income or suffer fiscal consequences.”
Work from Home
To drive its point home, the amicus brief then addressed the “unprecedented growth in work from home borne of the ongoing COVID-19 pandemic,” explaining that approximately “70 percent of U.S. employees ‘always’ or ‘sometimes’ worked from their home.”
Before the emergence of COVID-19, the brief explained, “more than 400,000 residents of amici New Jersey commuted to jobs in New York City (as did up to 78,000 residents of amici Connecticut).”[ix] However,
“This interstate travel came to an abrupt halt in March 2020, when rising COVID-19 cases compelled the New York Governor to prohibit employees of non-essential businesses from reporting to the workplace. Offices and stores in New York City were permitted to reopen in June 2020, but because of the ongoing pandemic, employers are still subject to various capacity limits, employers must take measures to reduce interpersonal contact in the office, and many former commuters keep working from home.”
Notwithstanding that these individuals were compelled, in effect, to work remotely from home, the briefs continued,
“New York made clear that nonresidents who are working from home due to the COVID-19 pandemic should consider their days working from home on account of these orders as ‘days worked in [New York] unless [their] employer has established a bona fide employer office at [their] telecommuting location.’ Given the stringent test for a bona fide employer office, residents working from home in amici New Jersey or Connecticut are virtually certain to fail New York’s test and will be required to pay income taxes to New York even if they never left the borders of their Home State.”
Given the number of individual taxpayers working from home, the brief concluded, “[t]he financial impact” of New York’s tax scheme cannot be understated. The tax credits that “home” States, like New Jersey and Connecticut, grant their residents who telecommute “to New York” will cost these States billions of dollars.
Query whether New Jersey and Connecticut realized at the time how remarkably prescient their amicus brief was with respect to the future of the workplace and the work-from-home culture that is now challenging many businesses and taxing authorities.
New Jersey “Makes a Move”
Of course, we know that in June of 2021 the Supreme Court declined to consider New Hampshire’s claim against Massachusetts and, by extension, New Jersey’s and Connecticut’s claims against New York.
Fast forward to September 2022. New Jersey’s Governor Murphy proposed legislation that would (i) provide a tax credit for New Jersey residents who successfully resist New York’s efforts to tax them on wages earned while working from their New Jersey homes; (ii) provide grants to out-of-state businesses that create in-state locations to which they would assign resident workers (basically re-assigning them from New York), thereby enabling New Jersey to tax their wages (and depriving New York of the opportunity to do so)[x]; and (iii) adopt a “convenience” rule that would apply to New York residents who work for New Jersey employers.[xi]
Jump ahead to January 2023. During his annual policy address at the State Capital, Gov. Murphy “proposed offering incentives to employers for establishing work-from-home and hybrid staffing policies in a bid to end” what Bloomberg News described as “the double taxation for residents who commute to New York City.”[xii]
According to Gov. Murphy, “In the new, post-pandemic business environment, not every new job created for a New Jerseyan is going to be housed in a physical office in New Jersey. For many New Jerseyans, working remotely is here to stay. So, let’s take this moment to focus on incentivizing jobs in New Jersey, wherever they are, regardless of whether they are in an office building in Newark or at a kitchen table in Cherry Hill.”
Connecticut Thinks About It
Meanwhile, on New York’s eastern front, Connecticut has tried a more conciliatory approach.[xiii]
In September 2022, as New Jersey was gearing up for a battle with its eastern neighbor, Gov. Lamont was reported as saying that his State “won’t be declaring war on New York or changing its tax policy.”[xiv]
However, in early February 2023, it was reported that “Connecticut’s top revenue officials said . . . they are evaluating a few options to address the annual loss of nearly $300 million in tax revenue due to a law that allows New York to directly tax the income of workers who live and work remotely in Connecticut.”[xv]
“The Revenue Department,” the article continued, “has repeatedly reached out to New York to discuss the matter, with little success.”
According to the Department’s Commissioner: “They’re not interested, because at the end of the day, they actually—in the swap of money, if you can picture that—they end up on the plus side. . . . We lose money in that particular transaction.”
David(s) and Goliath[xvi]
What is the likelihood that New Jersey and Connecticut will convince New York to drop its “convenience of the employer” rule? In light of New York’s historical reluctance to cooperate on tax matters with any of its neighbors, the chances of success are slim.
Moreover, it seems that New York’s appetite for more tax revenue will never be satiated. Even in the face of not insignificant reductions in the State’s population as taxpayers continue to move to low-tax jurisdictions, Albany continues to pursue tax increases, as well as new ways of pursuing asserted tax deficiencies.[xvii]
Where does that leave us?
The three neighbors have to recognize that none of them is an especially attractive jurisdiction for businesses and their owners. In fact, according to the Tax Foundation’s 2023 State Business Climate Index,[xviii] Connecticut, New York, and New Jersey are ranked at the bottom as follows: 47, 49, and 50, respectively. (California holds 48th place.)
Instead of competing with one another, these States need to find a way to work together. Addressing the convenience of the employer rule is a good place to start, especially if Albany wants to help New York businesses attract talented employees who are working remotely.
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The opinions expressed herein are solely those of the author(s) and do not necessarily represent the views of the Firm.
[i] Interestingly, one does not hear a lot about competition between New York and any of Massachusetts, Vermont, or Pennsylvania.
[ii] Each of which is governed by a member of the Democratic Party: Hochul in New York, Murphy in New Jersey, and Lamont in Connecticut.
[iii] For example, a State may tax a nonresident on their rental income from real property located in the State, or on their share of partnership income from a business operating in the State.
[iv] 20 NYCRR 132.18.
[v] Thereby subjecting the employer to tax in that State.
[vi] A number of factors are considered in determining whether a nonresident’s New York employer has established a “bona fide employer office” at the employee’s telecommuting location outside New York; specifically, the State in which the employee resides. It is no easy thing to demonstrate that these factors have been satisfied.
These factors are divided into three categories: the primary factor, secondary factors, and other factors. In order for an office to be considered a bona fide employer office, the office must meet either: (a) the primary factor, or (b)(i) at least 4 of the secondary factors and (ii) 3 of the other factors.
[vii] Woe betide any nonresident who owns residential property in New York. The first page of Form IT-203 asks whether the individual nonresident taxpayer or their spouse maintained living quarters in the State during the taxable year. The statutory residence test is alive and well.
[viii] The same analysis applies with respect to Connecticut.
[ix] As of mid-2021, New Jersey had a population of approximately 9.2 million while Connecticut’s population was approximately 3.6 million.
[x] Seriously? Tax tails and all that.
[xiii] That said, Connecticut applies its own version of the convenience rule only if a nonresident taxpayer’s resident state applies a similar rule. Thus, the rule would apply to a New Yorker who works in Connecticut.
[xvi] 1 Samuel 17. “The Lord who rescued me from the paw of the lion and the paw of the bear will rescue me from the hand of this Philistine.”
Query what stones Governors Lamont and Murphy may have in their bags to sling at Albany.
[xvii] An example of the latter: Gov. Hochul’s recent proposal to allow the State to appeal adverse decisions by the TAT.
Currently, decisions rendered by the Tribunal are final and binding on the Department of Taxation and Finance, i.e., there is no appeal to the courts. Taxpayers who are not satisfied with the decision of the TAT may appeal the Tribunal’s decision by instituting a proceeding pursuant to Article 78 of the CPLR to the Appellate Division Third Department.