New Jersey is officially back on offense against states like New York that maintain an aggressive approach to taxing out-of-state residents who work from home.

Gov. Phil Murphy on Friday signed a law that changes state income-tax policy for individuals and sets up a new tax-credit program for businesses that will be used to entice out-of-state companies to create new locations in New Jersey.

The same law also allows for new tax breaks to be offered to individual taxpayers who mount a successful legal challenge against states like New York that assert they have the right to tax the income of people working from home in another state if the company they work for is based in New York.

The law’s adoption comes as employees in many industries are now working from home permanently, or at least on a hybrid basis, under practices initially put in place as public-health measures during the worst years of the COVID-19 pandemic.

While such work settings have dramatically reshaped the modern workplace, they can also have major implications for state budgets, with potentially billions of dollars in income-tax revenue hanging in the balance.

Taxes and tolls

Meanwhile, the decision to fight back legally against New York comes as officials there are moving ahead with a plan to charge a new “congestion toll” on motorists who enter Manhattan below 60th Street.

Murphy and other elected officials in New Jersey have been highly critical of the New York tolling plan, arguing it would be unfair to New Jersey motorists who are already charged a toll by the Port Authority of New York and New Jersey when crossing the Hudson River into New York via bridge or tunnel. On Friday, Murphy announced a lawsuit against the U.S. Department of Transportation and the Federal Highway Administration over the “ill-conceived congestion pricing plan.”

No such tax conflict exists between New Jersey and Pennsylvania due to a long-standing reciprocal compact that allows residents to pay income taxes where they live, regardless of where they work. 

New Jersey’s tax laws generally dictate that income is “sourced based on where the service or employment is performed.” To prevent double taxation, the New Jersey Department of the Treasury has traditionally provided offsetting tax credits to residents for income taxes paid to New York and other states if their jobs are based there.

In the case of remote work, officials in New York have consistently viewed the work performed by employees of New York-based companies who are working from home in New Jersey and other states — even during COVID-19 lockdowns and the new work arrangements that followed — as a “convenience,” thus permitting the workers’ income to still be subject to New York’s tax laws.

New Jersey counts the cost

During the pandemic, New Jersey officials estimated more than $1 billion in tax credits would be paid out under current tax policies to homebound commuters to offset income taxes that New York collected from New Jersey residents working from home. No such tax conflict exists between New Jersey and Pennsylvania due to a long-standing reciprocal compact that allows residents to pay income taxes where they live, regardless of where they work.

In 2021, New Jersey was among several states that filed a legal brief in support of New Hampshire’s claim that Massachusetts had no right to collect income taxes from out-of-state residents working from home for companies based in Massachusetts.

Another provision of the law establishes state income-tax credits for residents who successfully mount their own legal challenge to the taxing of their income by another state when the income is earned while they are located physically in New Jersey. 

But the U.S. Supreme Court declined to take up the case, snuffing out New Jersey’s attempt to score a legal remedy to the bistate tax issue.

Last year, Murphy announced a legislative effort to address what he called an “unjust” tax-policy imbalance with states like New York that quickly gained bipartisan support.

Lawmakers have also noted the tax dispute involves revenue from income tax, which is constitutionally dedicated in New Jersey to funding property-tax relief.

Bipartisan support

Under the newly enacted legislation — which received overwhelming bipartisan support when it cleared both houses of the state Legislature late last month — New Jersey has now established its own “convenience of the employer” rule, but only for the income earned by people who work for companies based in New Jersey and reside in states like New York that have already established their own such tax law.

In addition, New Jersey has also earmarked $35 million for tax credits that will soon be offered to out-of-state companies with 25 or more full-time employees that set up locations in New Jersey for the purpose of reassigning New Jersey-based remote workers to the new locations so they can begin paying income taxes in New Jersey.

Yet another provision of the law establishes state income-tax credits for residents who successfully mount their own legal challenge to the taxing of their income by another state when the income is earned while they are located physically in New Jersey. Tax credits would also be provided to residents who seek and accept from their employers a reassignment from an out-of-state location to an in-state location, according to the law.