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The U.S. workforce is becoming increasing mobile, with employee's traveling throughout the country on behalf of their employer's. The presence of an out-of-state worker can implicate state income taxation with reporting and withholding obligations, an issue that a pending bill in Congress might simplify. In this article, Ernst & Young's Joe Huddleston discusses the burdens and complexities of determining when an employer is required to report and withhold out-of-state income taxes for a mobile employee.
By Joe Huddleston
Joe Huddleston is an Executive Director in EY's Indirect Tax Practice and is based in Washington, D.C. The views expressed in this article are those of the authors and do not necessarily reflect the views of Ernst & Young LLP.
For decades the U.S. economy has been evolving away from a manufacturing and industry into an economy built on the provision of service, and that evolution shows no signs of slowing. As more workers perform services within the scope of their employment as opposed to making tangible goods, and mobile workforce will continue to grow as businesses put their workers in planes, cars and trains to do their jobs at home and away. As the mobile workforce grows and travels around the country for work, more employers and employees are caught in a patchwork of state tax laws regarding income tax reporting and withholding. When does a nonresident worker owe income tax in a jurisdiction, and when is an employer required to withhold tax based on a nonresident worker's presence in a jurisdiction? These questions sound straightforward, but the complexities and administrative burdens mount when they are addressed on a 50-state basis for thousands of businesses and their employees.
There are two main ways to resolve this pressing issue: Congress can pass the Mobile Workforce State Income Tax Simplification Act of 2017 (H.R. 1393/S. 540), which would impose one federal law by which all states would then have to abide regarding nonresident worker income tax liability and withholding, or states could individually adopt the Model Mobile Workforce Statute approved several years ago by the Multistate Tax Commission (MTC) as part of its larger uniformity efforts. Various factors give both of these provisions potentially long odds of adoption or enactment, but giving employees and employers some level of certainty in this area via simplification of the rules would be a welcome relief for businesses. Only 23 states waive their nonresident income tax requirements based on de minimis earnings and/or time spent in the state, so in the meantime, businesses must carefully monitor their mobile workforces to stay in compliance.
Like several versions of federal mobile workforce legislation that were introduced during previous Congressional sessions, HR 1393 would limit the authority of states to tax certain income of employees for employment duties in other states. The bill provides that states cannot impose income tax on nonresidents, and the income is not subject to income tax withholding and reporting requirements, unless the nonresident works in the state for more than 30 days during the calendar year. On March 22, the bill passed out of the House Judiciary Committee to the House floor by a vote of 19-2. [ 55 DTR G-4]
Mobile workforce legislation has been under consideration for about a decade. Traditionally it garners bipartisan support, but the overall level of support has never been strong enough to make a new law. The closest mobile workforce legislation ever came to passage was 2012 and 2016 when it passed the House Representatives, but in both cases the Senate never considered it before Congress adjourned.
As federal mobile workforce legislation was gaining steam, the Multistate Tax Commission (MTC), at the request of the National Conference of State Legislatures, drafted and adopted the Model Mobile Workforce Statute. With input from various stakeholders, including the Council on State Taxation (COST), the MTC's model statute covers substantially similar matters as the federal mobile workforce legislation by holding harmless nonresident workers for income tax purposes and employers for withholding tax purposes, except that the hold harmless period is 20 days rather than the federal legislation's 30 days.
In the absence of a federal mobile workforce law or a majority of states adopting the uniform model MTC provisions, some states have chosen to engage in income tax reciprocity agreements, generally based on geographical proximity, in which, for example, Ohio residents who work in Kentucky do not owe Kentucky income tax, and Kentucky residents who work in Ohio do not owe Ohio income tax. However, while these reciprocity provisions are helpful and convenient on a small scale for the affected individuals and businesses, they contribute to the patchwork of laws that multistate businesses must take into account as they track where they must withhold and when.
Supporters of mobile workforce legislation traditionally have been businesses, while state governments that stand to lose money have traditionally resisted. Several organizations, including COST, the Federation of Tax Administrators (FTA), the National Governors Association (NGA), the MTC, and the NCSL have capably argued various points of view on this issue—including relief of administrative burden for employers and nonresident workers, increased enforcement burdens on the part of state governments and the placement of limitations on their ability to require employer recordkeeping, reporting, and withholding. However, there is really just one main roadblock: the issues presented by federal preemption.
Taxing income in the jurisdiction in which it is earned is a core state income tax concept, and the proposed federal legislation chips away at this with a blanket 30-day disallowance of income taxation for nonresident workers. Each state that has chosen to impose a nonresident income tax has affirmatively chosen to do so, and any federal measure that impairs that tool would go against the states' will. States could rightfully view the federal legislation as a substantial intrusion by the federal government on their own state sovereignty. Congress has already chipped away at this sovereignty through the passage decades ago of Public Law No. 86-272. That law generally prohibits a state from imposing net income tax on a business if its activities in the state are limited to the solicitation of sales of tangible personal property. States may understandably question—if the federal government is willing and able to restrict tie the states' hands and keep them from collecting income tax on nonresident workers for up to 30 days in a year, what is to stop it from disallowing state income tax collection on nonresidents completely?
From a practical standpoint, despite the bipartisan support that federal mobile workforce bills typically receive, states that stand to lose substantial money oppose this legislation. Although the Congressional Budget Office (CBO) has not provided an analysis yet on how much money might be at stake for states under the current legislation, it provided such an analysis in 2015 when Congress was considering a substantially similar mobile workforce bill, finding that the 2015 mobile workforce legislation would have cost states a net decrease of $50 million to $100 million each year. States that have large employment centers close to a state border would lose the most revenue, and states from which employees tend to commute would gain revenue. For example, the CBO estimated that, under the previous version of the mobile workforce legislation, which is very similar to the current bill, New York would lose between $50 million and $125 million per year—the largest revenue loss of any state—while New Jersey would likely gain revenue. California, Illinois, and Massachusetts would likely suffer smaller losses. According to the CBO report, the changes in tax revenues across the country would not net to zero because states tax income at different rates and on different bases.
Regardless of the states that may be winners and losers under this legislation, the increased mobility of the workforce is pressing this issue to be addressed somehow, whether it occurs through federal legislation or state enactment of uniform law provisions from the MTC. With the passage of similar legislation in the House in September 2016, and one-party rule in Congress after the 2016 general elections, the momentum at the moment may be with Congressional passage rather than multistate uniformity efforts. Only time will tell whether these simplification provisions, paired with the uncertainty related to potential comprehensive tax reform and the potential repeal and replace of the Affordable Care Act, will be passed to satiate an appetite for reform, or will be discarded again as one issue too many to address in a year with other ambitions for change.
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