State Taxation of Telecommuting

The year 2020 has brought us a new state tax issue.

To be fair, the issue is not totally new, but it has taken on importance with stay-at-home mandates.

Here is the issue: You work in one state but live in another. Which state gets to tax you when you are working from home?

Let’s start with the general rule: state taxation belongs to the state where the employee performs services, not the state where the employee resides. The concept is referred to as “sourcing,” and it is the same reason a state can tax you if you have rental real estate there.

Let’s follow that with the first exception: states can agree to not follow the general rule. Ohio, for example, has a reciprocal agreement with Kentucky. The agreement provides that an employee will be taxed by his/her state of residence, not by the state where the employee works.   A Kentucky resident working in Ohio, for example, will be taxed by Kentucky and not by Ohio.

Let’s pull away from the Cincinnati tristate area, however. That reciprocal agreement makes too much sense.

We need two other states: let’s use Iowa and Missouri.

One lives in Iowa and commutes to Missouri. Both states have an individual income tax. We have 2020, COVID and stay-at-home. An employee of a Missouri employer works from home, with home being Iowa.

Which state gets to tax?

This one is simple. Iowa.

Why?

Because both states have the same rule: the state of residence gets to tax a telecommuter.

So where is the issue in this area?

With states that are … less reasonable … than Iowa and Missouri.

Let’s go to Captain Obvious: New York.

New York has a “convenience of the employer” addendum to the above discussion. Under this rule, New York asks why the employee is working remotely: is it for the convenience of the employer, or is it for the convenience of the employee? The tax consequence varies depending on the answer.

* If for the convenience of the (New York) employer, then the employee’s state of residence has the first right to tax.

* If for the convenience of the (nonresident) employee, then New York has the first right to tax.

We for example have a Tennessee client with a New York employer who walked into this issue. He lives and works in Memphis, infrequently travelling to New York. We were able to resolve the matter, but New York initially went after him rather aggressively.

How does New York’s rule work with 2020 and COVID?

It doesn’t.

All those employees not commuting to New York were very much observing the convenience of their employer.

Clearly, this was an unacceptable answer to New York.

Let’s change the rule, said New York: the employee’s “assigned or primary” location will now control. If my accounting office was located in New York, for example, that would be my “assigned or primary” office and New York could tax me, no matter where I was.

How could I avoid that result? I would need to have my employer open a bona fide office where I lived. Some people could do that. Most could not.

Yessir.

There is no evolving tax doctrine here. This is ad hoc and reactive taxation, with much caprice, little constancy and the sense that New York will say and do whatever to lift your wallet.

There are few other states that follow this “convenience” rule: Pennsylvania, Delaware and New Jersey come to mind. It is more convenient for them to tax you than not to tax you, to reword the rule.

COVID introduced us to two more states feuding over the taxation of telecommuters: Massachusetts and New Hampshire. Massachusetts decreed that any employee who began working outside the state for “pandemic-related” circumstances would continue to be subject to Massachusetts income tax.

It is the same issue as New York, one might initially think. New Hampshire will allow a tax credit for the tax paid Massachusetts. The accounting fee goes up, but it works out in the end, right?

Nope.

Why?

New Hampshire does not tax W-2 income.

How do states like Massachusetts or New York justify their behavior?

There is an argument: Massachusetts and New York have roads, infrastructure, schools, universities, hospitals and so forth that attracted employers to locate there. Their tax is a fair and appropriate levy for providing and sustaining an environment which allows a person to be employed.

Got it.

Don’t buy it.

I grew up in Florida, which does not have an individual income tax. Somehow the state nonetheless has roads, infrastructure, schools, universities, hospitals and so forth. The only explanation must be divine intervention, it appears.

Additionally, if I lived in New Hampshire – and worked from there – I might prefer that my taxes go to New Hampshire. I after all would be using its roads, infrastructure, schools, universities, hospitals and so on, putting little – or no – demand on Massachusetts. I might in fact be quite pleased to not commute into Massachusetts regularly, if it all. It seems grotesque that Massachusetts will chase me across the fruited plains just because I need a job.

New Hampshire has filed a complaint against Massachusetts with the Supreme Court. The argument is rather simple: Massachusetts is infringing by imposing its tax on New Hampshire residents working in New Hampshire.  Interestingly, Connecticut and New Jersey have filed amicus (“friend of the court”) briefs supporting New Hampshire’s position. Their beef is with New York and not Massachusetts, but they are clearly interested in the issue.

I personally expect the expansion and growing acceptance of telecommuting to be a permanent employment change as we come out of COVID and its attendant restrictions. With that as context, the treatment of telecommuting may well be one of the “next big things” in taxation.

New York And State Donation Programs

You may have read that the new tax law will limit your itemized tax deduction beginning this year (2018).

This is of no concern to you if you do not itemize deductions on your personal return.

If you do itemize, then this might be a concern.

Here is the calculation:

        *  state income taxes plus

        *  local income taxes plus

        *  real estate taxes plus

        *  personal property taxes

There is a spiff in there if you live in a state without an income tax, but let’s skip that for now.

You have a sum. You next compare that sum to $10,000, and

… you take the smaller number. That is the maximum you can deduct.

Folks, if you live in New Jersey odds are that real estate taxes on anything is going to be at least $10 grand. That leaves you with no room to deduct New Jersey income taxes. You have maxed.

Same for New York, Connecticut, California and other high tax states.

Governor Cuomo said the new tax law would “destroy” New York.

Stepping around the abuse of the language, New York did put out an idea – two, in fact:

·       Establish a charitable fund to which one could make payments in lieu of state income taxes. When preparing one’s individual tax return, one could treat contributions to that fund as state taxes paid. To make this plausible, New York would not make the ratio one-to-one. For example, if you paid $100 to the charitable fund, your state tax credit might be $90. Surely no one would then argue that you had magically converted your taxes into a charitable deduction. The only one on the short end is the IRS, but hey … New York.

·      Have employers pay a new payroll tax on employee compensation, replacing employee withholding on that compensation.  Of course, to get this to work the employee would probably have to reduce his/her pay, as the employer is not going to keep his/her salary the same and pay this new tax.

Other states put out ideas, by the way. New York was not alone.

I somewhat like the second idea. I do however see the issue with subsequent raises (a smaller base means a smaller raise), possibly reduced social security benefits, possible employer reluctance to hire, and the psychological punch of taking a cut in pay. Ouch.

The first idea however has a sad ending.

You see, many states for many years thought that there were good causes that they were willing to subsidize.

·       Indiana has the School Scholarship Credit. You donate to a scholarship-granting charity and Indiana gives you a tax credit equal to 50% of the donation on your personal return.

·       South Carolina has something similar (the Exceptional SC), but the state tax credit is 100%.

New York and its cohorts saw these and said “What is the difference between what Indiana or South Carolina is doing and what we are proposing?”

Well, for one thing money is actually going to a charitable cause, but let’s continue.

This past summer the IRS pointed out the obvious: there was no charity under New York’s plan., The person making the “donation” was simultaneously receiving a tax benefit. That is hardly the hallmark of a charitable contribution.

Wait, wait, New York said. We are not giving him/her a dollar-for-dollar credit, so …..

Fine, said the IRS. Here is what you do. Subtract the credit from the “donation.” We will allow the difference as a deductible contribution.

In fact, continued the IRS, if the spread is 15% or less, we will spot you the full donation. You do not have to reduce the deduction for the amount you get back. We can be lenient.

So what have New York and cohorts done to Indiana, to South Carolina and other states with similar programs?

You got it: they have blown up their donation programs.

Way to go.

Why did the IRS not pursue this issue before?

Well, before it did not matter whether one considered the donation to be a tax or a deductible contribution. Both were deductible as itemized deductions. There was no vig for the IRS to chase.

This changed when deductible taxes were limited to $10,000. Now there was vig.

There are about 30 states with programs like Indiana and South Carolina, so do not be surprised if this reaches back to you.

Getting A Carr Out Of New York

Did you know that New York is likely to audit you if you move away from the state? These “residency audits” are infamous, as the outcome is rarely in doubt. They are the state tax equivalent of World Wrestling Entertainment.

I have never lived in a state that would not allow me to leave. There is something about such behavior that is highly disturbing.

I am reading Patrick Carr’s request for redetermination with the New York Division of Tax Appeals.

Carr is an attorney who was admitted to the New York Bar in 1964. He was later admitted to the New Jersey Bar. He followed the traditional New York migration pattern, and by 2007 he was living in Sarasota. He was retired, so he did not bother to move his law license to Florida.

He got involved with a case. Since he didn’t have a Florida license, the court allowed him “pro hac vice” status, literally meaning “this time only.” The court allowed him – as an out-of-state lawyer – to appear in court for a specific trial.

The case went on for a while, and he had legal fee income for 2007, 2008 and 2009. 

He reported the income on his federal return as self-employment income. There is no Florida individual income tax.

Wouldn’t you know that he got pulled for a residency audit?

New York conceded that he had successfully left New York.

That should have been the end of the matter, but …

New York still wanted its taxes.

The taxpayer received a large amount of money in tax year 2007 from a case he litigated in Florida. Schedule C income for 2008 and 2009 were relatively smaller compared to 2007. The taxpayer stated that all of his schedule C income from legal services was sourced to the state of Florida.”

Let a tax pro translate the above:

We want the money.

Back to New York: 

However, the taxpayer is not licensed to practice law in the State of Florida.”

Tax pro:                  

Sounds like a Florida problem.

New York:

It was determined that he was admitted as counsel pro hac vice in the Circuit Court of the 12^th Judicial Circuit in Sarasota County, Florida. This means that he was given special permission to help litigate this particular case even though you are not licensed to practice law in the state of Florida.”

Tax pro:

He received permission from the Court. Are there any other issues?

New York:

Therefore, all of your income is subject to New York income tax, since your income was attributable to a profession carried out in New York State….”

Tax pro:

By "carried out in New York State," do you mean Sarasota?

New York admitted he never did any of the work in New York, and also admitted that he was not a resident of New York.

Tax pro:

This was productive. Stay in touch.

New York nonetheless sent him a tax bill for $68 thousand, plus interest. They reasoned that his New York law license was enough to make him taxable in New York.

Tax pro:

Why is New York dissing New Jersey? Carr had a New Jersey license as well as a New York license. Why don’t you make it 50% to keep it fair?

New York:

He used to live in New York.

Tax pro: 

He used to go to college. Why don't you bill him for tuition also?

You already know this wound up in Court.

And the Court pointed out the obvious:

·        Carr did not have an office in New York

·        Carr did not practice in New York

·        Carr had an office or other place of practice outside New York

·        Carr had a license outside New York

·        He was authorized to practice in Florida. In fact, that is what pro hac vice means

·        Holding a New York license is not the same as carrying on a profession in New York

The Court told New York to go away.

What upsets me about state tax behavior like this is the cost and stress imposed upon the individual. I can see that Carr represented himself (“pro se”) in this matter, but he is an attorney. Most people do not have the training and likely would not represent themselves. They would have to hire a tax pro to fend-off a reckless challenge by New York or another state. Even if they win, they lose – after they pay the professional fees.

The Estate of Marilyn Monroe

There is a saying among tax pros: “do not let the tax tail wag the dog.” The point is to not let taxes so influence the decision that the final decision is not in your best interest. An example is failing to sell a profitable stock position for the sake of not paying taxes. Seems a good idea until the stock market – and your stock – takes a dive.

This past week I was reading about the estate of Marilyn Monroe. Did you know that her estate was the third highest-earning estate in 2011?  Her estate earned $27 million and came in behind the estates of Michael Jackson and Elvis Presley. What is driving this earning power?

What is driving it is “rights of publicity.” For example, the website Squidoo.com reports that Marilyn Monroe posters remain one of the top-sellers for students decorating their dorm rooms. A “right of publicity” exists at the whim of state statute. There is no federal law equivalent. Indiana is considered to have one of the most far-reaching statutes, recognizing rights to publicity for 100 years after death.

Marilyn Monroe divorced Joe DiMaggio in October, 1954. She then left California for New York. In 1956 she married Arthur Miller, and the couple lived In Manhattan’s Sutton Place. Marilyn still considered this her home when she died in Brentwood, California in August, 1962.

The executors of her estate had a tax decision to make: was her estate taxable to California (where she died) or New York (where she maintained the apartment and staff). They decided it would be New York, primarily because California’s estate taxes would have been expensive. By treating her as a New York resident, they were able to limit California to less than $800 in taxes.

Let’s go forward three or four decades, and states like California and Indiana now permit celebrities’ estates to earn large revenues, in large part by liberalizing property interests such as publicity rights. Some states have not been so liberal - states such as New York.

You can see this coming, can’t you?

Let’s continue. In 2001 The New York County Surrogate’s Court permitted the estate to close, transferring the assets to a Delaware corporation known as Marilyn Monroe LLC (MMLLC). The licensing agent for MMLLC is CMG Worldwide, an Indiana company that also manages the estate of James Dean. Is the selection of Indiana coincidental? I doubt it, given what we discussed above.

Marilyn is an iconoclastic image, and her photographs – and the rights to those photographs – are worth a mint. Enter Sam Shaw, who took many photographs of Marilyn, including the famous photo of her standing over a subway grate with her skirt billowing. The Shaw Family Archives (SFA) got into it with MMLLC, with MMLLC arguing that it exclusively owned the Monroe publicity rights.  SFA sued MMLLC in New York, and the court granted SFA summary judgment. The court noted that Marilyn Monroe was not a domiciliary of Indiana at her time of death, so her estate could not transfer assets to Indiana and obtain legal rights that did not exist when she died. She was either a resident of New York or California, and neither state recognized a posthumous right of publicity at her time of death.

MMLLC had no intention of rolling over. It called a few people who knew a few people.

In 2007 Governor Schwarzenegger signed into law a bill creating a posthumous right of publicity, so long as the decedent was a resident of California at the time of death. Even better, the law was made retroactive. The law could reach back to the estate of Marilyn Monroe. Wow! How is that for tax planning!

Now the estate of Marilyn Monroe started singing a different tune: of course Marilyn was a resident of California at her time of death. That entire issue of making her a New York resident was a misunderstanding. She had been living in California. She loved California and had every intention of making it her home, especially now that California retroactively changed its law 45 years after her death.

You know this had to go to court. MMLLC did not help by aggressively suing left and right to protect the publicity rights.

Last week the Ninth Circuit Court of Appeals (that is, California’s circuit) ruled that The Milton Greene Archives can continue selling photographs of Marilyn Monroe without paying MMLLC for publicity rights. The court noted that the estate claimed Monroe was a New York resident to avoid paying California taxes. The estate (through MMLLC) cannot now claim Monroe was a California resident to take advantage of a state law it desires.

NOTE: This is called “judicial estoppel,” and it bars a party from asserting a position different from one asserted in the past.

The appeals judge was not impressed with MMLLC and wrote the following:

"This is a textbook case for applying judicial estoppel. Monroe’s representatives took one position on Monroe’s domicile at death for forty years, and then changed their position when it was to their great financial advantage; an advantage they secured years after Monroe’s death by convincing the California legislature to create rights that did not exist when Monroe died. Marilyn Monroe is often quoted as saying, 'If you’re going to be two-faced, at least make one of them pretty.'”

What becomes now of MMLLC’s rights to publicity? Frankly, I do not know. It is hard to believe they will pick up their tent and leave the campground, however.

I am somewhat sympathetic to the estate and MMLLC’s situation. It was not as though the estate made its decision knowing that property rights were at stake.  At the time there were no property rights. It made what should have been a straightforward tax decision. Who could anticipate how this would turn out?

On a related note, guess whose case will also soon come before the Ninth Circuit on the issue of post-mortem publicity rights?  Here is a clue: he was from Seattle, had a four-year career and died a music legend. Give up?

It’s the estate of Jimi Hendrix.