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Bill to Standardize Taxation of Workers Temporarily in a State Advances

In short:
A bill to prohibit states from taxing most workers temporarily in the state until the worker performed services there for more than 30 days passed the House Judiciary Committee on November 17, 2011, and was sent to the full House for consideration.  Under the bill, employers would also not have to withhold until the 30-day standard is met, although once a worker exceeds 30 days in a state withholding would apply from the first day there. 

The Full Story:
Today’s tax quote:  “The smart money bets against tax reform-always and everywhere.  But every once in a while-usually a long while-the smart money is wrong.”  Joseph J. Thorndike.

Although fundamental tax reform has so far eluded the current Congress, a smaller incremental step forward occurred recently in a bipartisan vote of the House Judiciary Committee.

H.R. 1864, the “Mobile Workforce State Income Tax Simplification Act,” was approved November 17, 2011, by the House Judiciary Committee, and sent on to the full House for consideration.  This represents a substantial step forward for congressional and business advocates of legislation to provide uniform rules for state taxation of workers who are temporarily present in a state.  The bill, which reintroduces legislation that Congressman Johnson of Georgia has sponsored for several years, and which is supported by the Council on State Taxation (COST) as a much-needed way of standardizing what is now a very confusing patchwork of conflicting state rules, has not previously moved this far in the legislative process.   As passed by the Committee, the new law would be effective on January first of the second year beginning after enactment, which would give states and employers time to conform their systems to it.

Under the bill, a worker would continue to be fully taxable in his or her state of residence on all income, but would not be taxable in any other state unless the employee worked there for at least 30 days during the year.  Consistent with that standard, the employer would not have to begin withholding in the temporary assignment state until the employee had worked there for 30 days. 

Currently, employers face a different rule in every state.  According to testimony submitted by COST at a hearing of the Subcommittee on Courts, Commercial and Administrative Law of the House Committee on the Judiciary held on May 25, 2011, more than half the states technically require withholding to begin on the first day an employee earns wages there, while others have either time periods before withholding must begin, or minimum wage amounts before withholding must begin, or some combination of both.  Similarly, the rules for when an employee becomes taxable also vary from state to state, and are not always consistent with the rules requiring withholding.

H.R. 1864 would remedy that inconsistency by legislating a standard 30-day period both for taxability and withholding.  There would be no income threshold.  However, the 30-day limitation would not apply to entertainers, athletes, and other “public figures,” who generally are paid on a per event basis and would remain fully taxable in the state in which the income was earned.  The legislation would define a “day” as any day on which the employee performs “more of the employee’s employment duties within such State than in any other State during the day,” but would allocate all of the services to the nonresident state on any day in which the employee performs duties in both a nonresident state and the state of residence.  Consequently, if an employee who lives in Michigan worked in the morning in Illinois, and in the afternoon traveled to Iowa and worked there, both employer and employee would have to determine in which nonresident state (Illinois or Iowa) more of the employee’s duties occurred. 

Another potential pitfall in the way the bill is constructed is that once the employee crossed the 30-day threshold, withholding would have to take place for all of the 30 days already worked there.  A number of groups have testified that this rule will result in unfair cash-flow issues for employees, and should be changed to permit withholding adjustment over time, or to eliminate the retroactive withholding.  However, the Judiciary Committee left that aspect of the bill intact.

Not surprisingly, the states have consistently opposed this legislation.  Although analysis by COST suggests that the overall revenue loss to the states would be minimal, the legislation would shift revenue from some aggressive states (such as New York) to others, so that there would be winners and losers.  Indeed, one of the two Judiciary Committee members to oppose the bill was Rep. Nadler (D. NY), who argued that the bill would cost New York an estimated $100 million annually in lost tax revenue.   The states also object to the loss of control over their own tax systems, and to the some of the standards in the bill.  For example, although the 30-day standard is an improvement over prior versions of the legislation that would have imposed a 60-day standard, the Multistate Tax Commission (MTC, which is a federation of the states’ tax officials) still thinks the 30-day threshold is too long.   Opponents have also suggested that the bill may not pass Constitutional muster under the federal government’s authority to regulate interstate commerce.

In asking the Committee to defer action, MTC cited its own adoption in July of model legislation that is also aimed at standardization of tax treatment in the states.  Under the model statute advocated by MTC, the employee would become taxable, and withholding would be required, once the employee had worked in a state for more than 20 days.  Although MTC had previously argued for a monetary as well as days-worked standard (for example, an employee might become taxable once he or she had been working an aggregate of 20 days in a state, or earned $20,000 there), the model statute does not contain any minimum monetary standard.  The model statute has been adopted so far only by North Dakota, but MTC argues that many more states will follow.

The states also object to the standard in the bill for how employers would determine whether an employee had become taxable in a state.  H.R. 1864 provides that an employer is permitted to rely on an employee’s determination of time in a state unless the employer has actual knowledge of fraud by the employee, and is not required to use its own records for this purpose even if uses them for other purposes, except under limited circumstances in which it maintains a “time and attendance system that tracks where the employee performs duties on a daily basis.”   Under the MTC model statute, the employer would be subject to penalty unless it met one of three standards that rely on actual records of the whereabouts of the employee. 

There are also issues with the definition of a “day.”  The MTC model statute treats a “day” as any part of a day in which the employee performs services in a state, without the necessity to determine whether more of those services were performed in that state during that day than in any other.

Unfortunately, model statutes do not have to be adopted by any state, and can also be modified by any state adopting them, so it is unlikely that true consistency would actually result from the effort, even if the Congress agreed in full with the standards in the model statute.  As a result, the Judiciary Committee agreed in a bipartisan voice vote to proceed with a federal standard.  That action was supported by letters from the American Institute of Certified Public Accountants (AICPA), and from a group of over 100 major corporations.

Despite state objections, the two sides seem to be getting somewhat closer together.  Moreover, it is encouraging that the legislation has for the first time been approved by the House Judiciary Committee.  Although similar legislation has been introduced several times previously, it has never been put to a vote in either the House or Senate.  Worldwide ERC hopes this time around, it will receive more attention, since it would greatly simplify the task faced by ERC members trying to track and properly withhold on employees working in diverse locations.

Posted by Peter K. Scott

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