BY GREG MERMEL, C.P.A.
Staying on the right side of state income tax requirements is becoming more complex. The complexity lies not in any particular state’s laws and rules, though those of the more populous states (like New York and California) could nicely serve a smaller nation. Rather, it lies in the increasing numbers of people who have to file in more than one state.
A Basic Duality
The fundamental patterns have not changed. Individuals’ income is subject to tax in the state where it is earned, and each state taxes the world-wide income of its residents. This would mean that anyone who lived in one state and worked in another would pay tax twice, and that would not sit too well with the voters. A near-universal practice developed in which you are given a credit by your home state for the tax paid the other state, but only to the extent of the duplication in tax on the same income. Effectively, you pay the higher of the two rates on that income. Because of differences in how states calculate their tax, and how they calculate the withholding from wages, you can easily have a significant refund coming from the other state, and owe an equally large sum to Illinois.
What has changed is the enforcement by many states regarding nonresidents who work in the state. The ability of a state to enforce its laws against a business is determined by a subtle concept called nexus. A company has nexus with a particular state if it has sufficient commercial activity and physical presence in that state. Exactly what constitutes "sufficient" is not always clear, since the boundaries have been set by a series of court cases rather than by statute. This invites states to try.
Not too many years ago, all first-class theatre tours were managed from New York. A new production company was formed for each tour. It would withhold New York tax from employees’ paychecks for the weeks they rehearsed or performed in New York, and otherwise not withhold income taxes for any state. If they thought about other states at all (and I doubt they did), the producers felt that as a company with no permanent location outside New York, there was no nexus.
Now almost every tour manager carefully withholds state income tax for every state they pass through. What happened? First, a few states decided to assert nexus in a vigorous physical manner by seizing money from the box office. The theatre operators did not resist, since (a) it was not their money, and (b) they did not want to invite retaliatory audits of their own records. Other states, seeking ways to get taxes from people who voted elsewhere, jumped in.
Second, many tours are now produced by divisions of very large companies–like Disney or Clear Channel, which operate or have subsidiaries in all 50 states. They are already set up to do payroll taxes in those states, and pay corporate income taxes in those states, so the extra effort to collect and pay the taxes is minimal.
Not so for the performers and their crew. The agent for one of my musician clients told me today about a roadie whose W-2 from a rock tour last year showed withholding from 21 states.
Where Am I?
Exactly what part of an employee’s income is taxable in which state is not always clear, and is likely to become a contentious issue for employers. Illinois takes an especially expansive view, claiming exclusive jurisdiction over income paid to nonresidents if some of the service is performed in Illinois and the employer’s base of operations is in Illinois. According to the Chicago Sun-Times, Sammy Sosa is currently in litigation with the Illinois Department of Revenue over their denial of credit for taxes paid to all the other states where the Cubs play. There are also reports, which I have been unable to confirm, that New York tax authorities took a similar position with those tour producers who withheld New York taxes or none, and that some producers paid hundreds of thousands of dollars in back taxes.
Picking on Us
The new, aggressive attitude about collecting tax from those working temporarily in a state is not confined to performers. These days, I commonly see multi-state W-2s from management consultants, lawyers and computer geeks whose companies have sent them on assignments around the country. But where artists get the worst of it, at least for now, is non-employee fee payments.
Traditionally, independent contractors have not filed in states they did not live in. The nonresident state would have no reason to expect a tax return from that person, and probably did not even know that person had been there. And even if the state knew, that pesky nexus problem arises again: It is almost impossible for a state to force someone located elsewhere to submit to that state’s jurisdiction.
Some performers are more visible than others, not to mention better paid. The same state which would miss your children’s theatre group or chamber music ensemble would almost certainly notice Cher or the Rolling Stones. Many states have decided to ensure these taxes are paid by requiring withholding from payments to nonresident performers paid as independent contractors. These states figure that they are in a win-win situation. In many cases, a partial refund of the tax is due, but, of course, you have to file to get that; once you file, you have voluntarily given them authority to enforce their tax rules, including audits. If you don’t file, they don’t care because they already have the money.
California, being wise to the ways of the entertainment industry, pioneered this. They were so pleased with the results that they have expanded the withholding requirement to other forms of payment to nonresidents. Withholding on partnership profit distributions and real estate sales proceeds began a few years ago. And they now require withholding on fees paid to any and all nonresident independent contractors, not just performers.
Kind of makes you want to lock yourself in the bedroom and never leave.
Taxable In No State
Since copies of my "Checklist of Potentially Deductible Items for Actors, Designers and Others in the Performing Arts" are free, state taxes are not an issue. Just call or write me with your name and address.
Are there money or tax questions you would like to see discussed in this column? Let me know, at 2835 N. Sheffield, Suite 311, Chicago, IL 60657, or call 773/525-1778 (888/525-1778 toll-free outside the Chicago area) or e-mail greg@gregmermel.com.
Greg Mermel is a certified public accountant whose clients in the arts range from individual performers to major theatre companies and suppliers. He also sometimes produces theatre.