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By Lance S. Jacobs, Esq. and Ms. Callie Perkins
Pepper Hamilton LLP, Washington, DC
Recently introduced legislation aims to simplify global income tax reporting by establishing a national standard for filing and withholding income taxes for nonresident workers. Currently 43 states and the District of Columbia assess a personal income tax, each with varying rates and requirements. This causes confusion for workers and businesses alike when attempting to compute the proper amounts to report and withhold, respectively. In an increasingly mobile business community, more workers than ever travel for business. Technology further complicates the issue as the internet enables employees to work from home and businesses to conduct meetings remotely. Consequently, compliance will only become more difficult unless the administrative burdens are lessened.
The new legislation, the Mobile Workforce State Income Tax Simplification Act of 20111 (the Act), seeks to reduce the complexity of the varying rules in each state by limiting the authority of states to tax income of nonresident employees in most situations. Specifically, the Act would preempt conflicting state rules and establish a 30-day de minimis threshold for a state to be able to tax the income of a nonresident employee. Professional athletes and entertainers, as well as certain public figures, would be excluded from the Act because the majority of them are paid on a per-event basis. Compliance with the current system is both timely and costly as employees who travel outside their state of residence must file income tax returns not only at the federal level and in their home state, but also in every other state to which they travel for work, assuming that state is one of the 43 with a personal income tax. Employers face related difficulties in complying with varying withholding requirements. Not only is this inefficient for those filing income tax returns, but it is not beneficial for the states as it invites non-compliance.
The Act was previously introduced in 2006,2 20073 and 20094 as the Mobile Workforce State Income Tax Fairness and Simplification Act. After having undergone several modifications, the Act was most recently introduced in May 2011 by Reps. Howard Coble (R-NC) and Hank Johnson (D-GA).
The Federation of Tax Administrators (FTA) has opposed the bill from the outset. The FTA's chief argument is that the Act would intrude upon state sovereignty and tax authority and too greatly impact state tax revenues, while not having an adequate federal justification. In 2007, the FTA argued that the Act directly conflicted with the guiding principle of state tax policy that income should be taxed where it is earned or where the services giving rise to the income are performed. It also took issue with the original 60-day shelter for nonresident employees as opposed to the 30-day tax-free shelter as currently proposed. The FTA argued that a 60-day threshold would allow individuals to "conduct substantial amounts of economic activity within a state" without having to pay taxes on such activity, effectively creating "tax havens" that would substantially and negatively impact state tax revenues. The FTA was particularly concerned about the negative impact on places such as New York City, to which many workers travel for temporary work periods. To limit the negative impact upon state revenues, the FTA proposed a two-tiered system for exemption, consisting of both a time component of some time less than 60 days and a value component with a maximum dollar amount allowed to be exempted.
At a recent hearing, representatives of the FTA again testified against the Act. Despite reducing the period from 60 days to 30 days, the FTA still believes that the Act "invites tax avoidance" and intrudes upon state sovereignty. It is concerned that the Act does not make clear that it is limited to wages only and wants the Act to more definitely say that states may still tax non-wage income earned within the state. It also still favors a two-tiered system with an added value component. Furthermore, the FTA does not support the "physical presence standard" for the imposition of tax liability as written in the current bill.
Multiple proponents firmly advocate the Act's administrative simplicity. With ever-increasing numbers of workers traveling for business, usually for a limited amount of time, the varying filing and administrative requirements are exceedingly outdated and inefficient, and creating a uniform standard is the most practical solution. Although reciprocity agreements are meant to ameliorate compliance burdens, they only make tracking responsibilities more difficult because they only extend to states that have agreed to be included, and there are multiple such agreements between various states.
The AICPA argues that the current system takes resources away from businesses, particularly small businesses that are forced to hire additional staff to comply with the varying requirements of each state where they do business. These costs are subsequently passed on to those businesses' customers and clients, thus impeding interstate commerce. Considering all the different ways in which states tax income and the difficulty of identifying all the different reciprocity agreements, recordkeeping becomes more burdensome as employees travel more often. To simplify administrative compliance for all, proponents argue, the best solution is to establish a national standard for filing and withholding income taxes when doing business in multiple states. The AICPA argues that doing so would not only stimulate interstate commerce, but would also invite compliance and benefit the states. It maintains that any concerns opponents of the Act have about individuals and businesses avoiding tax liability or shifting liability to a state with a lower rate are addressed by the 30-day shelter rule.
COST supported its endorsement of the Act by providing details on the withholding requirements in varying states. For example, Arizona does not require withholding if a nonresident is in the state for fewer than 60 days, but Maine's threshold is only 10 days. A uniform standard would provide certainty for employees when filling out their income tax returns and create greater efficiency for businesses. COST says that the effects on state revenues would be negligible at best. This is because all states that levy a personal income tax also provide credits for nonresident personal income taxes paid to other states. Based on the most recent figures available provided for the 111th Congress, COST estimates that 44 states either gain a small amount of revenue or lose only 0.01 percent or less.
The bipartisan support for this bill is encouraging, as in our increasingly mobile economy, where geography is relatively unimportant but it is nonetheless necessary to travel at times to a customer location, business travel is at an all-time high. The perception that employees are spending a minimal amount of time in each individual location yet are traveling to multiple locations, seems to be correct. If this perception is correct, the economic justification for withholding income tax from an employee for a minimal amount of time spent in a jurisdiction seems flimsy at best, as the state in question is not really providing many services to the employee that allows him to work there.
The FTA's arguments for the status quo seem flimsy – the whole point behind the state tax credit system, whereby a resident of a state gets a credit on his or her income tax return for taxes paid to other jurisdictions, is to ensure that the employee is not out-of-pocket as a result of his or her travel. While there are imperfections in the system because of the way that differing states calculate the credits allowed (typically, for example, a resident of a state with a lower tax rate does not get a full credit for taxes paid to a state with a higher rate that he visited as a non-resident), it seems that the proposed legislation would reduce these imperfections. Further, conceptually, it is hard to understand how this could have a significant impact on the states as a whole, as the reduction in non-resident tax revenue would be offset by fewer credits given to residents for non-resident taxes paid. The FTA's defense seems to be less about reducing some systemic unfairness and more about retaining marginal revenues.
For more information, in the BNA Tax Management Portfolios, see Maule, 525 T.M., State, Local, and Federal Taxes.
© 2011 Pepper Hamilton LLP
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