Alabama Rules that a Nonresident’s Wages Earned While Working Out-of-State are Taxable

At a glance

• The main takeaway: A recent case in Alabama concluded that a nonresident’s wages earned while working remotely out-of-state were subject to income tax, and this represented a departure from long-standing policy regarding when a nonresident’s wages are subject to income tax.
• Assess the impact: This departure presents challenges as employees may find themselves dealing with unintended double taxation for wage income, and employers must ensure they pay withholding taxes and unemployment contributions to the appropriate state.
• Take the next step: Aprio’s State and Local Tax (SALT) team has experience overseeing remote work tax issues and can help your business determine any new state tax compliance obligations, so you do not incur unexpected tax liabilities and penalties. 

Schedule a free consultation today to learn more!

The full story:

Employees are generally familiar with the rule that the state in which they perform their services for their employer, determines the state in which such wages are taxable.¹ However, remote work has become increasingly popular since the COVID-19 pandemic. So, how has the demand for remote work impacted the way states treat out-of-state employees who perform services for in-state employers? 

A recent Alabama Tax Tribunal (Tribunal) decision concluded that although the taxpayer had abandoned his Alabama domicile when he moved to Idaho, the wages he earned while performing service in Idaho for his Alabama employer were subject to Alabama income tax.²

A closer look at the case

The taxpayer worked and lived in Alabama at the beginning of 2020. When COVID hit, his job became remote, and he worked from his apartment in Alabama. In September 2020, he obtained permission from his supervisor to permanently relocate to Idaho, which he did, and he continued to work for his employer from his new residence in Idaho until October 2021. When he received his 2020 W-2 from his employer, all of his 2020 wages were reported as Alabama wages.³ Nonetheless, the taxpayer reported to Alabama only the wages earned for the days he was working in Alabama. The Alabama Department of Revenue (DOR) assessed him for the additional income tax based on the W-2, and this appeal ensued.

The Tribunal addressed two issues:

• First, it concluded that the taxpayer had abandoned his Alabama domicile and became a nonresident upon his move to Idaho. The Tribunal noted that the taxpayer testified that he relocated to Idaho with the intention of making Idaho his permanent residence. In addition, he gave up his Alabama apartment, had no property in Alabama and voted in the 2020 election in Idaho. Although the taxpayer maintained his Alabama driver’s license through 2021, he explained that he did so because the license was still valid. The Tribunal noted on that issue, that maintenance of an in-state driver’s license is not the sole determination of domicile, and that the totality of the facts surrounding the taxpayer’s move support that he became a nonresident upon his move to Idaho.

• Second, the Tribunal addressed whether his wages earned while working in Idaho for his Alabama employer should be sourced to and taxed by Alabama. Under Alabama’s statute, a “nonresident individual receiving income from property owned or business transacted in Alabama” is subject to Alabama income tax.⁴ The state’s regulations provide that “where compensation is received for personal services rendered partly within and partly without this State, that part of the income attributable to this State is included in gross income. In such cases the test of physical presence is used to determine the situs of the rendition of the services . . . .”⁵

The ruling explained

In examining whether the taxpayer received income for “business transacted in Alabama,” the Tribunal noted that the taxpayer was engaged in business with his employer, which was located in Alabama. While the taxpayer contended that his wages earned while performing services in Idaho should not be sourced to Alabama, the Tribunal disagreed, stating that:

Because of the availability of remote work, however, the Taxpayer’s physical presence in Alabama was not needed in order for him to maintain his employment in Alabama. . . The Taxpayer testified that he was able to continue his duties while working remotely and reported to the same Alabama supervisors to whom he had reported while working physically in Alabama.

Accordingly, the Tribunal concluded that the taxpayer continued to transact business in Alabama, and therefore, his wages were subject to Alabama income tax.

The bottom line

This case represents a departure from prior Alabama policy (and the policy of almost all states) that a nonresident employee’s wages are sourced to where the services are performed. Clearly, the Tribunal was influenced by the availability of remote work during the COVID and now post-COVID years, but should the growth in remote work necessitate a departure from the long-standing policy in almost all states regarding the taxability of employee compensation?

Such a departure presents challenges for employees, who may find themselves dealing with unintended double taxation of wage income if their resident state does not offer a credit for the taxes paid to states that adopt different sourcing rules for remote work. Employers are also at risk, as they need to ensure that they are paying withholding taxes and unemployment contributions to the appropriate state as well as assessing their nexus risks for income tax and sales and use taxes.

Aprio’s SALT team has experience with the new remote work tax issues, and can assist your business to determine any new state tax compliance obligations, so that you do not incur unexpected tax liabilities and penalties. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

_¹ There are a handful of states that apply what is referred to as the “convenience of the employer” rule that treats certain wages earned by employees on days telecommuting outside their assigned office as taxable in the state of that office.

² Mark E. Bollinger v. State of Alabama, Department of Revenue, Docket No. Inc. 22-390-LP, Alabama Tax Tribunal, March 8, 2023.

³ According to the taxpayer, he attempted to obtain a correct W-2 but his employer was not able to obtain one because the employer did not have an Idaho business presence. It appears that the employer did not register for an Idaho withholding tax account – perhaps it should have.

⁴ Ala. Code. § 40-18-2.

⁵ Ala. Admin. Code r. 810-3-14-.05(1)(b)2.