When it comes to nonresident income taxes, the states are all over the map, with laws that are often highly complex and difficult to comply with. The situation has long been a nightmare for individuals who travel from state to state to do business — and for their employers. In some cases, companies must monitor an employee’s travel location hour by hour to satisfy state and local income tax requirements.
It’s only gotten worse with the rise of telecommuting and hybrid work. Complicated, confusing and conflicting laws can result in double taxation for some people who work remotely for a company in another state. In many states, even occasional remote or hybrid work or work-related travel can trigger nonresident individual income tax filing, withholding and payment requirements.
Complying with nonresident income tax rules can cost more in accountant fees than the taxes themselves. And many states lack the manpower to monitor nonresidents remote work and business travel. The difficulty is compounded because many states have localities with their own income taxes, which include nonresident taxes. In Ohio there are hundreds of such local income taxes. In Pennsylvania there are thousands. The result is widespread noncompliance and loss of tax revenue for the states.
The Tax Foundation Proposes Changes
A new study by the Tax Foundation, “State Individual Income Taxes on Nonresidents: A Primer,” looks at the crazy quilt of state and local income tax rules for nonresidents and proposes changes that would ease the burden for individuals, businesses and the states themselves. The easiest solution — federal legislation imposing uniform nonresident tax standards on the states — is unlikely, the authors say. But they offer suggestions on how states can prune the thicket of complex and conflicting laws, making the them more attractive places to work and do business.
The report notes that every state with an individual income tax offers credit for taxes paid to other states. The result is that a taxpayer pays a total tax equal to the amount they would have owed if taxed only by the state with the higher tax rate. Agreements between states can alter the way two states divvy up the individual’s taxes, such as reverse-credit rules and reciprocity agreements, but the total tax remains the same for the individual.
However, a hybrid work situation can increase the complexity of tax reporting and withholding for workers and employers. The individual and business are expected to keep track of the number of days the employee works in each state, which can become onerous if time in the office varies from week to week.
That burden is eased under reciprocity pacts, where nearby states agree that for cross-border workers, only the state of residency imposes an income tax. Such agreements ensure that taxes stay in the state where the worker receives the most benefit from state services. “For all these reasons, more states should consider adopting reciprocity agreements with nearby states,” the report authors write. Currently, there are 30 reciprocity agreements among 15 states and the District of Columbia.
‘Convenience’ Rules Are Anything But for Workers
However, some states use an employer-friendly “convenience tax” rule for nonresidents that can result in double taxation for individuals who work remotely. Under such rules, individuals who work outside their employer’s state are treated as if they work there. However, eligibility for interstate income tax credits typically does not extend to residents who physically work in their home state. The result is that those individuals face double taxation where all their work income is exposed to both states’ individual income taxes.
States that impose aggressive convenience tax rules undercut their competitiveness, the authors say, because telework-friendly employers are more likely to relocate or shift operations to offices elsewhere to protect their employees. Eight states — Alabama, Connecticut, Delaware, Nebraska, New Jersey, New York, Oregon and Pennsylvania — have convenience rules in their tax codes, but three apply their convenience rule only in limited situations. States with such rules should repeal them, and other states should avoid implementing them, the Tax Foundation says.
“It is aggressive and constitutionally dubious overreach, however, for states to expose all or much of a nonresident’s income to in-state taxation simply because their employer is located there, especially when those individuals rarely step foot in the state and do not directly benefit from public services provided in that state,” the authors write.
Reporting and Withholding Confusion
States vary widely in their requirements for when workers and employers must report and withhold nonresident income, which can cause difficulties in variable hybrid work situations and multistate business travel, according to the report.
In the most burdensome examples, five states require individuals to file nonresident individual income tax returns if they receive any income sourced to the state, no matter how little. Other states have reporting and withholding thresholds based on the amount earned in the state. Often, the threshold amount matches or is similar to the state’s standard deduction or is based on the federal standard deduction. But in some cases, states set the threshold level so low as to make reporting and withholding mandatory for virtually everyone. In Vermont, the threshold is $100.
Other states use the number of days worked in state as the basis for reporting and withholding thresholds. The number varies from state to state, but many require reporting and withholding after 30 days of work. However, many states have mutuality requirements that apply the threshold only if the worker’s home state has a similar rule.
Some states have both an income threshold and a day threshold for reporting. Only Indiana and Montana have a day-based reporting threshold without a mutuality requirement or income threshold. Both states require nonresidents to file after they have worked in the state for over 30 days.
Targeting Athletes and Rockers
To ensure taxation of high-profile high earners, many states single out professional athletes, professional entertainers, public figures and “key employees” for tougher enforcement. However, such “jock taxes” and similar policies can unfairly sweep up in their net low-paid workers, such as minor league baseball players, athletic trainers, backup singers and concert support staff, the authors say.
Noting that some minor league players are paid under $20,000, the authors write, “affected individuals are forced to expend significant resources each year in their efforts to comply with a highly complex nonresident state income tax landscape. This can involve filing dozens of nonresident income tax returns and paying substantial sums to any state in which the taxpayer earns income.”
Indeed, nonresident income tax rules are often so complicated that individuals who are required to file them would have to spend more on accountant fees than they owe in taxes. And while states and many localities have strict reporting and withholding requirements, they lack the resources to enforce those rules. The result is widespread noncompliance.
“Many individuals have little incentive to spend $60 or $70 per state to use tax filing software to file nonresident income tax returns in states they owe a fraction of that amount of tax liability to, especially knowing their total tax liability will frequently remain unchanged due to credits for taxes paid to other states, and anticipating that states have little expectation of compliance,” the authors write.
Ed Prince is a writer for Rethinking65. In a four-decade career in journalism, he has served as an editor with many of New Jersey’s leading newspapers, including the Star-Ledger, Asbury Park Press and Home News Tribune. Read more of his articles here.
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