Arkansas DFA legal opinion effectively adopts convenience of the employer test

With telework on the rise, the state taxation of remote employees has become a hot issue.  The Arkansas Department of Finance and Administration has published Revenue Legal Counsel Opinion no.  20200203 (Feb. 20, 2020), which adopts what is effectively a "convenience of the employer" test imposing income tax on remote, out-of-state employee income where the employee is working for an Arkansas-based office.  This policy marks an apparent reversal of the rule in DFA's Individual Income Tax Regulation 1.26-52-202(c), which requires allocation of nonresident employment income based on where the work was performed.

The employee at issue in the letter is a computer programmer working out of Washington State, which does not impose an income tax.  The programmer had lived in Arkansas working for employer on-campus and then moved to Washington in 2017 and continued working remotely, performing essentially the same services.  The question appears to have been posed to DFA Revenue Legal Counsel with little argument or analysis.  (And it is much to the credit of Revenue Legal Counsel in routinely providing opinion letters responding to these kinds of questions.)

Much of the DFA opinion discusses a state's constitutional authority to impose a tax on a nonresident's income, looking to whether "the State of Arkansas has given something for which it can ask a return."  The opinion then bases imposition of tax on the proposition that the remote employee is carrying on an occupation in Arkansas within the meaning of Arkansas Code Annotated section 26-51-202, despite the employee "performing her job duties from a physical location outside of the state."

While Legal Opinion 20200203 does not use the language "convenience of the employer," it appears to be effectively adopting that rule: imposing tax based on the employer's location, not the location of the employee, where the employee's remote location is not needed by the employer but rather is for the convenience of the employee.  (For example, in Opinion 20200203, the computer programmer apparently has moved to Washington State for personal reasons while remaining employed by the Arkansas employer; that employer did not appear to have a business reason for the move to Washington.)  The handful of states that have adopted a convenience of the employer test (e.g. New York, Pennsylvania, Connecticut) generally set it out expressly by statute or regulation.  New York, for example, provides that "any allowance claimed for days worked outside New York State must be based upon the performance of services which of necessity, as distinguished from convenience, obligate the employee to out-of-state duties in the service of his employer."  20 CRR-NY 132.18(a).

The legal opinion does not consider and appears to contradict DFA's own Individual Income Tax Regulation 1.26-52-202(c), which allocates employment income based on where the work was performed.  Arkansas Code Annotated section 26-51-202(c) requires that income be "properly allocated."  Rule 1.26-52-202(c) provides that the allocation should be based on where work is performed: "Where a nonresident individual is paid a salary, lump sum payment or some other form of payment which encompasses work performed both inside and outside of Arkansas, Arkansas income tax should be paid only on that portion of the individual's income that can be reasonably allocated to work performed in Arkansas."  (Emphasis in the original.)  Opinion 20200203 expressly recognizes that the work at issue is performed outside of Arkansas: "Although your client performs her work duties in Washington state, those activities impact computer systems and computer users in Arkansas...."  (Emphasis added.)  Rule 1.26-52-202(c) thus would seem to require a contrary conclusion on the facts presented from that reached in Opinion 20200203.

DFA Revenue Legal Counsel's de facto adoption of a convenience of the employer test seems to have crystallized in recent years.  In Opinion 20150202 (May 26, 2015), Revenue Legal Counsel advised that a professor in Ohio owed Arkansas income tax on income from a class taught remotely for an Arkansas university.  Revenue Legal Counsel has also advised that an out-of-state employer did not need to withhold Arkansas income tax on a remote employee in Arkansas in Opinion 20190514 (Feb. 3, 2020).  We are not aware of any ALJ Administrative Decisions or Director's Revisions thus far addressing these issues.  One may argue that DFA is departing from the interpretation provided by Rule 1.26-52-202(c) without going through a proper rulemaking process.

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