The convenience of the employer test: why we should reconsider the critique of New York's tax apportionment scheme.

• Author: Borie, Brian C.
• Position: COMMENTS

1. INTRODUCTION

   In recent years, telecommuting has become increasingly popular in the United States. (1) An employee telecommutes (or "teleworks") when that employee is paid by his or her employer for work done at a location other than the employer's office. (2) Most often, this location is an employee's home. (3) Telecommuters often use laptop computers, additional phone lines, and handheld devices to complete their job responsibilities from outside the office. (4) As technology advances, opportunities to telecommute will continue to arise throughout the United States. Provided that an employer finds telecommuting to be an appropriate management technique for the company, employees elect to telecommute for myriad reasons, such as cutting commuting time, reducing living expenses, or simply wishing to be closer to the employee's family. (5)

   As telecommuting increases throughout the United States and across state lines, accurate methods of taxing telecommuters will become more important to individual states. States have substantial discretion to develop their own tax schemes, and many states have approached the tax treatment of telecommuters differently. (6) New York, however, has encountered significant criticism for the application of its tax scheme: the "convenience of the employer" ("convenience") test. (7)

   New York's convenience of the employer test derives its power from the interplay of several New York tax statutes and tax regulations. Section 601(e)(1) of the New York tax law taxes all income "which is derived from sources in this state." (8) Section 631(c) of the tax law adds:

   If a business, trade, profession or occupation is carried on partly within and partly without this state, as determined under regulations of the tax commission, the items of income, gain, loss and deduction derived from or connected with New York sources shall be determined by apportionment and allocation under such regulations. (9) The relevant tax regulation to which the tax law refers is section 132.18(a) of Title 20 of the Codes, Rules, and Regulations of New York. (10) Section 132.18(a) states that:

   If a nonresident employee ... performs services for his employer both within and without New York State, his income derived from New York State sources includes that proportion of his total compensation for services rendered as an employee which the total number of working days employed within New York State bears to the total number of working days employed both within and without New York State. (11) Since this language would create a simple physical presence apportionment formula, (12) the regulation further requires 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." (13)

   Individuals who support an alternative method of taxation, the "physical presence" test, have severely criticized the convenience test. (14) States that employ this simplistic formula consider the number of days the employee physically worked within a state and tax the employee only on those days. (15) When states use this test, they surrender to the "state of physical presence" potential tax revenue from the days the employee worked in that other state. (16) For example, an employee ("EE") works for company X, which is based in state A, and lives in state B. If EE works 125 days at X's office in state A and 125 days at home in state B, then both state A and state B will each tax EE (at their respective state income tax rates) for working 125 days.

   Despite two rulings by the Court of Appeals upholding the constitutionality and validity of the convenience test, commentators and scholars have continued to criticize New York's approach to the taxation of telecommuters. (17) In this article, I will address and dispel the most common criticisms of the convenience test.

2. THE HISTORY OF NEW YORK'S CONVENIENCE TEST

   1. The Development of the Convenience Test

      New York State's taxation of nonresident employees of New York based companies is not a new concept. The method of taxing these individuals, however, has changed throughout the last century. In 1919, the former New York Attorney General, Charles D. Newton, issued a report that articulated the state's original stance on the taxation of nonresident employees. (18) In this report, the former Attorney General framed the issue by defining the "source" of taxable income. (19) He stated that "[i]t seems to me that the work done, rather than the person paying for it, should be regarded as the 'source' of income." (20) He continued, stating that "[w]here services are rendered partially within and partially without the [s]tate, the income therefrom should be divided pro rata into income from sources within and without the [s]tate." (21) Many feel that this Attorney General report established the "place of performance" test in New York. (22) This "place of performance" test, or "physical presence" test, stood as New York's primary method of taxing nonresident employees until the late 1950s. (23)

      In 1960, however, the definition of the "source" of taxable income was modified by the enactment and recodification of several tax statutes and regulations. (24) The enactment of these statutes and regulations caused the primary apportionment scheme in New York to change from the "place of performance" test to the "convenience of the employer" test. (25)

      Even before the enactment of the tax laws and regulations in 1960, New York courts had already begun applying the convenience test. In Burke v. Bragalini, (26) a taxpayer tried to claim that the forty days that he worked at home, where there were fewer interruptions, did not qualify as New York workdays. (27) The Third Department rejected this, stating that "[i]t is understandable that many people ... may on occasions find it more advantageous to work at home, either during the regular working hours or extra 'home work' after hours" but "[s]uch a person living in the [s]tate is not entitled to special tax benefits and ... [therefore] the commuter from outside the [s]tate is entitled to no such special benefits." (28) The court additionally focused on the fact that there was no proof that the employee could not have done his work at a research library within the New York office. (29)

      Probably the earliest and most influential application of the recodified tax apportionment scheme was in Speno v. Gallman. (30) In Speno, a New Jersey resident, who worked from home for a significant portion of the year, debated his tax returns from 1960 and 1961. The Court of Appeals focused mostly on the scope of the taxpayer's business duties at home. (31) The court noted that the taxpayer did not perform several important business activities at home: he did not receive business calls nor did he meet with any local clients. (32) The court applied the convenience test and held that the taxpayer could have very easily performed his tasks in the New York office (33) and it was not necessary for the employer that the taxpayer worked from his home. (34) The court unanimously agreed that the taxpayer was liable but, most importantly, the court made a point to clarify how the past understanding of "source" was replaced by the new definition under the revised tax law. (35) After clearly acknowledging the replacement of the place of performance test by the convenience test, the court also distinguished, but did not misinterpret, (36) other precedents that applied the former test. (37)

      Throughout the next thirty years, numerous cases fine-tuned the parameters of the convenience test. In Gross v. State Tax Commission, (38) the taxpayer worked from his home because it was more convenient for him and because it increased his productivity. (39) The Third Department held that the tax law required a necessity to work from home, and not simply a mere convenience, to avoid tax liability. (40) According to the court, increased productivity was clearly related to convenience, not necessity. (41) The court held that the taxpayer could just as easily have performed his work at the New York office. (42) Therefore, applying the convenience test, the court did not allow the taxpayer to apportion his days worked at home as non-New York workdays. (43)

      In Fass v. State Tax Commission, (44) an editor of numerous magazines worked from his New Jersey home. (45) These magazines dealt with a wide range of topics including cars, firearms, and animals. (46) In contrast to Gross, the Third Department held that Mr. Fass did work from home out of necessity. (47) The court held that because the taxpayer needed "specialized facilities" to test and review the specialized products for his magazines it was necessary, as an essential part of his job, to work from his New Jersey home. (48) The court, therefore, held that Mr. Fass was not liable in New York for the days worked at his New Jersey home. (49) The court additionally noted that simply because the taxpayer could have operated special facilities somewhere else within New York State, it did not automatically mean he should be liable for New York taxes. (50)

      In Colleary v. Tully, (51) a New Jersey resident worked under two different contracts for his New York employer. (52) The first contract involved his supervisory position at the New York company while the second contract involved his writing tasks, which were to be done entirely at his New Jersey home and a nearby New Jersey office. (53) The taxpayer claimed that the convenience of the employer test was improperly applied to both contracts, arguing that his writing contract involved no connection with New York and that his employer did not provide him with an office in New York to write. (54) The court, however, rejected the taxpayer's position, stating that it is not the individual contracts but the single employment...