The Entrepreneurial View #472                                                               

The Tax Man and Telecommuting

by Raymond J. Keating

The greedy hand of government seems to know few bounds, and too often, entrepreneurs and small businesses pay the price.

On Wednesday, the New York Times published a special small business section.  One of the articles was titled "Telecommuters Cry 'Ouch' to the Tax Code".  It noted that a few states - with New York being the most aggressive - assess their state income taxes on the out-of-state, telecommuting employees of in-state firms, even if those employees only come into the state for work occasionally.

You might ask: Huh?

Note the key points from the Times article:

• "Many employees in this tax situation are forced to prepay taxes all year for two states, even if their own states will ultimately credit them for taxes paid elsewhere. Others, unaware that they are responsible for paying income taxes in another state, find out only at tax time that their employers have not withheld enough. They end up having to write big checks to a state where they receive virtually no services."

• States like New York extend its income tax to telecommuters living in other states if telecommuting was for their own convenience, and not due to a job requirement. "The convenience rule holds that if an employee of a New York company works outside the state as a job requirement, he is subject to income tax for only those days that he works in New York. But if the same worker chooses to work outside New York for his own convenience, he is subject to income tax on his entire income. An exception is made if the worker never visits New York during the tax year."

• New York's highest court has ruled against two nonresident taxpayers who challenged New York's "convenience" rule in the past five years, and the U.S. Supreme Court has declined to hear either case.

And what about small businesses?  The Times reported: "This tax issue is of growing urgency for small businesses, which often run lean operations and rely on a scattered work force. Those that are aware that their distant employees are required to pay taxes in the company's home state - and tax experts say that few really are aware - could be faced with the extra administrative task of keeping track of different state tax laws and adjusting withholding rates." The article noted the case of a small manufacturer on Long Island that is in the midst of a two-year battle with New York tax authorities because the company's president moved to Florida in 2002.

By the way, it was reported that the company is now going to move to Florida or the Carolinas due to this tax battle.  And the jobs of 52 employees will be gone as well. That doesn't seem to work out too well for the New York economy, does it?

According to the story, a spokesman for the state's Department of Taxation and Finance argued that the convenience rule "was necessary to prevent people from overstating how often they work from an out-of-state home to try to minimize their New York tax bill. ‘One of our main concerns is the potential for abuse,' he said."

In reality, of course, this is just a glaring example of a state with very high taxes trying to pull in even more revenue through any possible means - even by reaching across state lines and taxing an individual who does not live or really work in the state.

New York's high taxes have driven away individuals, businesses, investment and jobs. Now the state's tax authorities are chasing away even more businesses due to this inane "convenience" tax rule.

But it is not just New York that should concern businesses and telecommuters.  The article noted one tax expert warning that other states might take their lead from New York and come to see "nonresident telecommuters as an untapped revenue stream."

In addition, states that credit taxpayers for taxes paid elsewhere could end up with no tax revenues from a telecommuter who lives and uses services within the state. As for states that offer no such credits, taxpayers wind up being double taxed - paying taxes in each state for the same work.  Either way, this makes no sense.

There is federal legislation proposed to eliminate this blatant case of tax unfairness towards telecommuters and small businesses. U.S. Senator Christopher Dodd, a Democrat, and U.S. Rep. Christopher Shays, a Republican, have co-sponsored "The Telecommuter Tax Fairness Act of 2007." 

The legislation declares: "In applying its income tax laws to the compensation of a nonresident individual, a State may deem such nonresident individual to be present in or working in such State for any period of time only if such nonresident individual is physically present in such State for such period and such State may not impose nonresident income taxes on such compensation with respect to any period of time when such nonresident individual is physically present in another State."

That is an obvious solution to a costly tax overreach by some states. Congress should act immediately in the name of fairness and common sense.

_______

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.