3-2-07
Getting Lucky
In my last column, I wrote about going out of town for business. This week, I want to look at the state tax consequences of your getting lucky and actually finding out-of-town work.
Oh, you thought I meant something else? Get your mind out of the gutter: this is a family newspaper.
Serving Two Masters
State income taxes involve two different general principles. One says that income is taxed by the state where it is earned. The other says that each state taxes all of the income of its residents, wherever it might be earned.
The inherent contradiction is resolved, and the issue of double taxation minimized, by a third general principle: the state where a taxpayer resides gives a credit against its tax for the tax paid the work state, but only to the extent of the duplication. For example, the effective tax rate on an actor’s work in Missouri might be 1.6 percent. Illinois has a flat tax rate of 3 percent, so he could claim an Illinois credit for all of the Missouri tax. Massachusetts, though, has a flat 5.3 percent tax on most forms of income; that actor could only claim a little over half his Massachusetts tax as an Illinois credit.
This general rule has some big exceptions, generally involving contiguous states where many people regularly cross the border to work. Illinois, for example, has a deal with Wisconsin, Iowa, Kentucky and Michigan. Wages (but not other forms of income) earned by an Illinois resident in any of those four states are subject only to Illinois tax, and vice versa.
There Are Principles
The first principle – that income is taxed where it is earned – is a little wobbly. Each of the 43 states with income taxes has its own laws, its own regulations and its own body of court rulings. No two states match, of course, so the results are contradictory.
Where the income was actually earned is not always obvious, and sometimes two states will claim the same income.
States also have different taxation thresholds. Minnesota allows you to earn $1,500 within the state without tax liability, but Ohio collects tax from the first dollar of in-state income.
Then there are two practical issues. How aggressive is the other state in collecting tax from nonresidents? And will the other state even know you were there?
Squeeze ‘Em
If you stayed awake in your high school civics class, you learned that the United States Constitution reserves exclusively to the federal government the right to regulate interstate commerce. This means that a state’s ability to enforce its laws ends at its borders. As a result, someone arrested in state A for a crime that occurred in state B is not just handed over to the state A police. Rather, state A must formally ask state B to extradite the suspect, who has the opportunity to appear in state B’s courts and make a case as to why he should not be sent back.
Extradition is only for criminal acts (and not even all of those). If you work in California and don’t file a California tax return, Gov. Schwarzenegger can’t request you be forcibly returned there to do so.
Instead, states increasingly use a simple form of coercion: tax withholding. “We have your money,” they taunt, “probably more than the taxes would be. Voluntarily” (yeah, right) “file a state return, or lose out on the refund.”
Withholding Is New?
State tax withholding is nothing new for ordinary, same-employer-in-one-place jobs. However, states have become much more aggressive about demanding employers switch wage withholding to that state when an employer sends you there temporarily. Ten years ago, virtually all theatre tours were operated from New York, and they withheld New York taxes or none. Now, a bus-and-truck tour can easily need to withhold taxes from 10 states each year. The states are not picking on actors. Management consultants, computer programmers and the like have the same issues, though they may be better paid.
No state wants to try to tax someone who, say, attends a convention or flies in for a one-day meeting, so they all have some sort of de minimis rules. A worker must be in the state for more than a certain span of time, or earn more than a certain amount in the state, before wage withholding is required. As with all else, no two states’ rules are the same.
Wages are not the only form of income that a nonresident might earn. Fee income traditionally was essentially invisible to the state where it is earned, and the rule of thumb was to only file a return if the state knows you were there. Celebrity is a factor, of course: Britney Spears is a lot more conspicuous than a solo performer working nursing homes.
But states increasingly know other people were there by requiring withholding from fee payments. A number of states have special rules requiring state withholding from the fees paid performers. California now requires withholding from any fee payment to any nonresident – not just performers. Other states will undoubtedly copy this, in the usual beggar-your-neighbor game of taxation. After all, whatever extra tax dollars California collects from this effort are probably a credit against some other state’s taxes.
This is really a zero-sum game both for the states and for taxpayers, with two exceptions. First is the difference in tax rates between states. The credit out-of-state being limited to the amount of the duplication in tax means you pay the higher of the two taxes. Illinois is generally a low income tax state, so we tend to lose when we work elsewhere.
The second exception is the cost to employers and taxpayers of managing the additional state withholdings and doing the filings. This does bear more heavily on performers than on other workers. Performers are more likely to work out-of-state; I typically prepare tax returns for more than 30 states each year, mostly for my arts clients. And they often make less, so the cost of compliance is proportionately high.
Free Offer.
If you would like a copy of my free “Checklist of Potentially Deductible Items” for those in the arts, just write, call or e-mail my office. We’ll be pleased to send you one.
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 has also been known to produce theatre.