Simplifying compliance for the mobile workforce - looking at state costs

States need revenue and one place they can and do look is to see if an individual or business is in their state who does not pay taxes. One example getting heightened attention by states, employers, employees and Congress is an employee working for a few days, weeks or months in a state. The state wants to be sure the employer is withholding tax on wages paid to the worker and the worker pays income tax in the state (assuming they meet the filing threshold, which varies from state to state).

There are a few complicating factors in all of this, such as:

• The rules vary from state to state as to when an employer must start withholding state tax on the employee. The thresholds might also vary as to whether based on days worked or meeting an income threshold. The Council on State Taxation (COST) has a nice map showing these differences (see Appendix A of their May 2011 testimony before the House Judiciary Committee).
• The rules vary from state to state as to the income tax filing requirement for the visiting employee. The employee has added compliance costs including filing returns in some states to get a refund of overpaid taxes.
• Employers find it challenging to track where employees were each pay period, getting that information to operate with the pay system so as to get the right state withholding, and also factor in issues of annual bonuses or similar type payment. The withholding issue can be challenging beyond the technology pieces in that while the state visited may want withholding, the employee may still or instead owe income tax to his state of residence and will expect that state income tax withholding has been made.

One proposal moving along to help alleviate some of the complications is H.R. 1864. A hearing was held in the House Judiciary Committee on May 25, 2011 and the committee voted favorably on the legislation on November 17, 2011. H.R. 1864 basically provides that no withholding is required of a non-resident employee unless the employee "is present and performing employment duties for more than 30 days during the calendar year in which the income is earned."

The Multistate Tax Commission (MTC) has a Model Mobile Workforce Statute proposal in their review process. This proposal uses a 20-day threshold before withholding is required.

As required by the Unfunded Mandates Reform Act, the Congressional Budget Office (CBO) prepared an estimate to see if H.R. 1864 would violate the UMRA. They could not tell. Per CBO (1/25/12):

"Most states that levy a personal income tax allow residents to take a credit for income taxes that the residents pay to another state. The cost of the mandate would equal, for all states collectively, the difference between the amount of revenue that states receive from nonresidents who work in the state for fewer than 31 days and the amount they would receive from residents whose credits would be lower under the bill. Generally, states that have large employment centers close to a state border would lose the most revenue; states from which employees tend to commute would gain revenue. For example, New York would likely lose the largest amount of revenue—from $50 million to $100 million according to state and industry estimates—and Illinois, Massachusetts, and California would face smaller losses. New Jersey and Connecticut would likely gain revenue. Because of uncertainty about the amount of revenue that states collect from nonresidents, and the amount they would receive from residents whose credits would be lower under the bill, CBO cannot estimate the net cost of the mandate. Consequently, CBO cannot determine whether the net cost of the intergovernmental mandate in the bill would exceed the annual threshold established in UMRA ($73 million in 2012, adjusted annually for inflation)."

I think a few things are interesting about the CBO report:

• It would seem that there would be minimal revenue loss or gain for the states in aggregation. After all, if a State Z employee today works for a few days in State X and has to pay tax in State X, he likely gets a credit in State Z. If the employee works for a few days in a state without an income tax, the employee's home state will have him report all of his wages, just as is done today.
• New York will likely lose the most under H.R. 1864 per CBO.  Well, that seems to be because New York and just a few other states use a "convenience of the employer" test to determine where a worker's wages should be taxed. The result is that New York can grab a lot more wages than if it instead only taxed an employee for the time spent working in New York. (For more on this, see a September 2009 article on the mobile workforce issue I wrote for the AICPA - still timely, just the bill numbers have changed!)  Hopefully, H.R. 1864 would not be held up because some states that aggressively grab employee wages today will lose revenue under H.R. 1864.  In the aggregate, it doesn't seem that is the case (other than for some wages of mobile employees who reside in states without an income tax). And states should question why New York (and a few other states) want to grab more employee tax than they are entitled to.

Another issue is whether this is something the states via the MTC should resolve or if Congress should resolve it. Given a poor track record of voluntary, 50-state conformity for tax matters, it seems that Congress will have to address this issue in order for there to be conformity.  This has been a longstanding issue and Congress has a lot on its plate.  Will H.R. 1864 be enacted before the 112th Congress ends?

What do you think?