State and local taxes often present exposure traps for businesses. Each state—and many local governments—can create and assess its own taxes. The lack of uniformity among the taxing jurisdictions means that meeting these obligations is difficult and costly. Yet if a state finds a non-compliant taxpayer, the taxes, penalties, and interest can be even more costly, particularly if the taxpayer is unprepared by never having realized the existence of the tax obligation.
Members of Congress are extremely sensitive to the needs of their constituents, especially small and medium-sized businesses. When business executives call their members, their members listen, and one of Congress’s core duties is protecting interstate commerce from unfair state taxes.
As it heads into the final weeks of its session, Congress is considering various bills that would restrict or expand states’ taxing authority. Almost every business in the country would be affected by at least some of these bills.
While some of these bills have progressed further than others, any could become law—particularly if bundled into legislation that Congress must, as a practical and political matter, pass before the session ends. Businesses thus have an opportunity to ask their Senators and Representative to take action to rein in some of the problems with state and local taxes:
- The Mobile Workforce State Income Tax Simplification Act, which would provide relief from state income tax and related withholding obligations on traveling employees.One of the most nightmarishly complex areas for employers with travelling employees is state income tax withholding. A state is entitled to tax income earned within its borders, which can be taken to an extreme when a state expects its share of income of a high-earner who spends merely a few days in the state. The Mobile Workforce State Income Tax Simplification Act would fix this by providing a 30-day bright-line rule before a state can impose tax on the employee or withholding obligations on the employer, albeit with an exception for athletes and entertainers.
- The Business Activity Tax Simplification Act, which would keep states from unfairly imposing income taxes on out-of-state businesses. “Taxation without representation” may have been the rallying cry for the American Revolution but has become today’s popular state tax policy. States try to export their tax burden with “economic nexus,” making an out-of-state business subject to state income tax (or other direct tax) solely because the business has in-state customers. Public Law 86-272, which was enacted over 50 years ago, protects some sellers of tangible personal property from some of these excesses but does not extend to sellers of intangible property or services or to states that have direct taxes other than income taxes, (such as Texas, Ohio and Washington). The Business Activity Tax Simplification Act would modernize Public Law 86-272 by expanding its principles to all businesses so that a physical presence test would prevent unfair state taxation of out-of-state companies.
- The Marketplace Fairness Act, which would let states make online retailers collect sales tax. The rise of online retail has hurt states’ sales tax receipts. Since businesses without a physical presence “nexus” in a state are not required to collect that state’s sales tax, many online retailers do not do so. Online retailers contend that this is fair because the potential burden of complying with states’ sales tax systems is overwhelming. Bricks-and-mortar retailers, on the other hand, believe that the current physical presence test leads to unfair competition. The Marketplace Fairness Act attempts a compromise by allowing states to make out-of-state sellers with $1 million or more of annual sales collect tax, but only if the state meets certain tax-simplification requirements. The bill has passed the Senate, but in recent weeks Republican leadership in the House has expressed reluctance to enact it.
- The Internet Tax Freedom Act, which must not be allowed to expire. Congress in 1998 banned states from taxing internet access or imposing discriminatory taxes on electronic commerce. (Considering the heavy state tax burdens on other forms of telecommunications, this was visionary.) But the Internet Tax Freedom Act expires on December 11. The House has passed and the Senate is considering legislation making the Internet Tax Freedom Act permanent (H.R. 3086). It is critical that this be enacted to avoid giving states free rein to tax internet access, especially since states have largely been operating under the assumption that the Internet Tax Freedom Act will be extended and are not ready to begin collecting taxes on internet access.
The bills under consideration could change the landscape of state taxes. Both the Mobile Workforce State Income Tax Simplification Act and the Business Activity Tax Simplification Act would ease unreasonable state tax burdens on interstate businesses. The Marketplace Fairness Act would expand sales tax collection obligations for some online retailers while also providing for sales tax simplification.
And the Internet Tax Freedom Act is critical to protecting internet access and electronic commerce from burdensome state taxes. Given the flux of the current lame- duck session, interested businesses should press Congress to act on these bills in order to streamline and simplify unreasonable state tax obligations.
Arthur R. Rosen is a partner and Matthew C. Boch is an associate in the law firm of McDermott Will & Emery LLP.