Multi-State Contractor Question

[Snaggletooth]

New client is headquartered in Alabama, and has three federal contracts, one in Alabama, one in Kansas, and one in Georgia. Contract specialty is software development.

All employees work from home in Alabama, and develop software on their home computers. The owner makes only a couple days trip to Georgia and a couple days to Kansas. One of the other employees made one trip to Georgia during the year.

I've discovered all employees are paid totally on an Alabama payroll, and their latest Federal tax return (SMLLC electing an S Corp) has not filed either a Kansas or Georgia non-resident return.

Not interested in whether Kansas or Georgia want a return or not - all the states want tax money whether appropriate or not. For example either state might put filing requirements in their instructions, but they are not sovereign to the contractor.

Your opinions are solicited as to whether a Kansas or Georgia return is required.

[kathyc2]

If all the work was performed in AL, then the W-2 should all be AL income.

I'm not familiar with what constitutes Nexus in GA or KS, but unless they are very strict doubtful if corporate returns are due for those states. One of the western states, WA I believe, has very strict rules as to what creates Nexus. IIRC, if a salesperson spends even one night in the state then Nexus is in effect for 3 years.

[Snaggletooth]

More Info

Hi Kathy - Since I posted a couple days ago, I've found out more information.

I will refer to the Washington State situation of which you speak. All of the states are reaching out for all the revenue they can, and I don't know that State definitions of their own making create a "real world" situation where corporations should respond. For example, I would determine whether existence of only one day in the state calculates to a dollar amount exceeding filing threshholds before giving in to this.

I have found out that five states have been successful in defining a "convenience" ruling. They are New York, New Jersey, Pennsylvania, Delaware, and Nebraska. It is an idea which may prove so popular to other states, that they can easily make a similar definition. It has been upheld by at least one court case in New York, and I believe New Jersey retaliated quickly. It works like this:

If the source of the income is in one state, and the worker is working from home as a matter of convenience rather than necessity, then the worker is subject to taxation in the state of source. If there is a job requirement that causes him to have a NEED to work in his resident state, then taxation (if any) is limited to # days spent in state of source.

It follows that any state taxation for workers creates a need for the corporation to file a corporate tax, due to various allocation formulas which are in place.

Some of the states also define sales as being either origin sales or destination sales, and claim a right to revenue if a company has either type. I don't know that the sovereignty of their state can dictate this or not. I know California defined "destination" sales in their ongoing war against Amazon, and their purpose was not so much corporate tax as it was sales tax.

Comments are still welcome...

[TAXNJ]

You are correct that states are looking for revenue from almost any source. The issue you are raising has been posted many times e.g., see 6-17-13 post: Multi State Corporate Taxes. Also, there are many others similar multi state posts for payroll, etc that you have replied to some of those posts.

You mention that "I know California defined "destination" sales in their ongoing war against Amazon, and their purpose was not so much corporate tax as it was sales tax". Yes, many states are adopting this "sales tax" strategy without much complaint from most of the general public! So the states see it as a source of revenue.

Compliments to you for resurfacing this challenging issue. Such a complicated issue that there are firms that specialize in this area.

[Nashville]

No Way to Win

There might be no settlement as to how to handle this outside of a Supreme Court decision (as happened with non-resident states trying to tax retirement income).

With the power vested in these states, the huge problem is this falls down on the individual. The individual cannot tell two states to take each other to court and slug it out. The non-resident state says "We don't care what happens in your state, we want "our" money." Likewise the resident state says "We don't care what happens somewhere else, you live here and we are entitled to our money no matter where you earned it."

A Kentucky resident works from home at his own convenience, and the source of the work is New York. Under New York's "convenience" rule, the employer has to withhold NY tax and issue a W-2 showing NY wages. However, even though the work is in New York, the employer could be in Texas. Does this Texas employer have more responsibility to NY than to KY? Is he more obligated to withhold NY taxes than KY? The employer is most likely a corporation with multi-state taxation on the corporate level. There must be an allocation of Sales, Payroll, and Investment amongst states. How is this allocation performed?

New York courts don't have to abide by Kentucky court rulings, and vice-versa, so the burden of potential double-taxation falls entirely upon the individual and the employer. I foresee a growing need for a package of these issues to be decided by the Supreme Court at some point. Even with "credit for taxes paid to other states" there is still double-taxation, and withholding issues outside this credit.

States have sometimes coalesced into forming "multi-state compacts" but they have largely failed because not all the states will join. Some of the states will withhold their support because they don't want to be fair if it means losing revenue.