NY and its neighbors need a tri-state coronavirus tax compact

Work in the New York-New Jersey-Connecticut tri-state region will never be quite the same. During the coronavirus lockdown, tens of thousands of office workers who once commuted an hour or more to jobs in Manhattan have worked from home, often quite happily despite the challenges of being with their family during the workday. Businesses once wary of potential productivity losses have been pleasantly surprised, and many are now reevaluating their need for an expensive footprint in midtown or downtown Manhattan. Although Manhattan’s commercial real estate sector will probably retain its central role in the regional economy, businesses and their employees will be wary of returning wholesale to the pre-pandemic paradigm of high-density offices.

Alongside other economic and social impacts, a future that includes more flexible and remote work arrangements will surely disrupt the pre-crisis allocation of tax burdens between New York and its neighboring states. To prevent wasteful bureaucratic border wars and avoid imposing impossible complexity and uncertainty on taxpayers, the governors of New York, New Jersey and Connecticut along with New York City Mayor Bill de Blasio should task their senior tax administrators with negotiating a regional compact to address both short- and long-term tax issues arising from the COVID-19 crisis. Billions of dollars and our region’s long-term competitiveness are at stake.

What would such a compact or agreement encompass? Given the sudden increase in remote work, the initial focus should be on updating administrative rules and practices with respect to the tax treatment of employees who have ceased to commute across state lines and who are now working from home.

Under long-established principles of interstate taxation, employees pay state income tax to the jurisdiction where they earn their income (and generally receive a credit against their resident income taxes for any taxes paid to another jurisdiction). So, for example, a New Jersey resident who commutes to a job in Manhattan pays nonresident income tax to New York State on her income earned in New York; her New Jersey tax bill is reduced due to the New York tax paid.

But what if New Jersey residents work remotely for a New York-based company or the New York office of a company based in, say, California? Prior to the COVID-19 crisis, the states in our region (led by New York) generally took the position that they were still liable for nonresident taxes in respect of days worked at home in another state unless their work at home was by necessity, “as distinct from convenience.” Stated alternatively, they would be responsible for New York nonresident taxes unless the nature of their work required them to work in New Jersey, for example if they were responsible for a sales territory that included only New Jersey.

This subjective approach, difficult to enforce without exposing taxpayers to intrusive audits and the risk of double taxation, has long been a cause of considerable tax tension across our region. The pandemic crisis has exacerbated this tension and related administrative problems, presenting an immediate issue as to whether working from home under lockdown orders constitutes employer necessity. Although the answer may seem obvious – yes, days working at home under lockdown should not be subject to nonresident income tax – the short- and long-term implications are not. Over the short term, for example, New Jersey and Connecticut might be tempted to welcome a windfall of income tax revenue at New York’s expense. But caution is indicated. New York state would no doubt fight to protect its tax base with every means at its disposal, including more audits and expanded tax incentives. If the other states respond in kind, the resulting border wars will inevitably burden both employers and employees throughout the region while, counterintuitively, generating less tax revenue.

The issues extend beyond the nonresident income tax. For example, will the states in our region count days sheltering or caring for a family member outside one’s domiciliary (or home) state during the pandemic toward the 183-day statutory threshold for applying resident income tax? What about New York City residents who spent most of this year at second homes in New Jersey or Connecticut to avoid the worst of the COVID-19 outbreak in the city? Similarly, will New York and its neighbors impose corporate income tax on a company whose only contact with the taxing state is an employee working from home under a coronavirus lockdown? Although the states have already signaled some short-term flexibility on this question, what will happen as employers and employees settle into sustained remote work arrangements post-crisis?

These are just a few of the tax issues that should be addressed as part of reopening our regional economy. It’s a challenging agenda but there is some good news. All the jurisdictions have strong technical staff and a history of interjurisdictional cooperation. Our region boasts a depth of nongovernmental expertise including an active community of tax practitioners who have already expressed an interest in contributing their expertise.

Despite historic rivalries, the economic futures of New York, Connecticut, and New Jersey will remain inextricably bound together. Although some level of tax competition is healthy, negotiating a tax compact offers a chance to coordinate tax policies and practices across the region to avoid wasteful bureaucratic border wars, reduce uncertainty for taxpayers and employers, and protect our region’s competitive position.