Tax & Business Insights

State Tax Collectors Get Aggressive

Volume 22 Issue 4 --  July/August 2010

Some cash-starved states are looking for workers temporarily toiling in their states as a new or expanded source of tax revenue.  Some maintain that the TEA Party acronym stands for the protest slogan “Taxed Enough Already.” If TEA party members are irked by being taxed too much, it is imagined that they will be further irked by being subject to state income tax in multiple states.

For years, state tax collectors relied on newspapers and similar reports of the activities of well-known athletes, artists and entertainers traveling to their location.  Those days are fading. With the advent of computers and databases it is now possible for states to be much more vigorous in their efforts to collect state income tax on work done in their state.

For example, Pert Uppon, (Pert) installs software systems and provides training throughout New England , so she is subject to state income tax in many different states.

According to The New York Times of March 22, 2010, the state of New York takes the position that if you work one day in New York then 1/250th of your salary for that year is subject to tax in New York. Often, states taking a similar position do not have to read the newspapers to locate workers, like Pert. If Pert worked for a large company, it may monitor and withhold amounts for the payments of Pert’s tax debt to each state in which she worked. Or there may be 1099s to provide evidence of work.  

Stated differently, Pert may receive multiple state W-2s or 1099s reflecting her compensation earned in various states. Will Pert be happy about having to file income tax returns in multiple states and being subject to audits in such states? Probably, not.

Of course, state taxation is subject to certain constitutional limitations. One limitation is that a person or activities must have a minimal level of connection — often called “nexus” — with a state before the state can levy its taxes.

Traditionally, nexus was often thought to require physical presence in a state. Thus, for a worker or contractor like Pert, coming into a state more than just occasionally would subject her to its  income tax.

More recently a number of states have been trying to expand the concept of nexus to include a more “economic” definition of nexus. In part, this has been triggered by aggressive multi-state corporations that seek to reduce their state tax exposure by employing complex rental or licensing arrangements to shift income from higher tax states in which they conduct operations to lower (or no) tax states.

In some cases, courts have upheld a state’s attempt to reach some income under economically-based nexus theories, but the Supreme Court has yet to settle this issue, so further efforts by aggressive states can be expected.

Because of credits available for taxes paid to other states, all of this activity may not increase the total tax bill for multi-state operators like Pert, but it certainly can increase the costs of doing business in multiple states. Moreover, the various state credit schemes are not perfect and often do not result in a credit in one state equal to the tax paid in another state.

Similarly, in the sales and use tax arena, some states have been trying to expand the scope of nexus beyond traditional physical presence in the state. A number of states, for example, have adopted or are considering so-called “Amazon statutes,” referring to Internet seller, which  often has “affiliate” relationships with in-state residents who receive compensation for various acts associated with referring or soliciting customers for an out-of-state seller. Under US Supreme Court decisions, a state cannot impose its sales tax law on an out of state seller who has no “presence” in the state, but it is unclear how these “Amazon statutes” will fare in the courts.

More recently, some states have adopted a different tactic to extend their sales tax collections. Instead of requiring Internet-only or out-of-state sellers to collect sales tax, they are trying to require these out-of state sellers to turn over lists of customers in a given state so that the state can go after them directly to collect use taxes.

The New York Times article mentioned above posed the interesting question: Should President Obama, who allegedly visited 30 states in 2009 be subject to filing state tax returns in all 30 states?

One can expect states only to continue their efforts to expand their tax revenues even though it is unclear where all of this will lead. Tax professionals need to be aware of how these developments can affect their clients with multi-state activities. In some cases, choice of entity planning can play a role in state tax compliance.

If you have questions about the tax consequences of underwater mortgages, please contact the Tax & Business Professionals.

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