Weekly SSRN Tax Article Review And Roundup: Saito Reviews Holderness’s Individual Home-Work Assignments For State Taxes

This week, Blaine Saito (Northeastern; Google Scholar) reviews a new work by Hayes Holderness (Richmond), Individual Home-Work Assignments for State Taxes, 98 Wash. L. Rev. ___ (2023).

The COVID-19 pandemic pushed much of work online. But this move to greater remote work raises issues for state taxation of that labor income. In his piece Individual Home-Work Assignments for State Taxes, Hayes Holderness makes a convincing case that the dominant view that the employees’ residency jurisdiction should be the only one able to tax this labor income is misguided. The result is a thoughtful and forceful argument that the states where the employer is located should be allowed to tax remote work income.

Holderness first notes that the Constitution allows the employer’s state, the source state, to tax the income even in a remote work situation. He further argues that it is unlikely that the Supreme Court is going to reverse course and limit source states’ rights to tax this income.

Perhaps the most important part of the Constitutional analysis is one piece of the dormant Commerce Clause test. It is the idea of nondiscrimination between interstate and intrastate taxpayers. This piece is perhaps the only remaining Constitutional law issue with bite. Obviously, a tax that is facially discriminatory is disallowed. But even if a tax is not facially discriminatory, it can violate the dormant Commerce Clause if it fails Pike balancing, which balances the state’s interests against the burden placed on interstate commerce. Here, the test almost always favors the states. Their interests in revenue are a strong state interest. The burdens on interstate remote work taxpayers, on other hand, are limited. They do have the compliance burden of filing in the employer’s state, but so do interstate commuting workers. That latter burden has always been seen as reasonable under Pike balancing. Furthermore, the idea that remote workers are overly burdened by double taxation is misguided. States credit taxes a resident taxpayer pays to other states, and such a mechanism also ensures nondiscrimination here. Furthermore, the overall push of the Supreme Court has been one of respecting state sovereignty. The Court has withdrawn, striking down only the most egregious violations here.

But Holderness’s most powerful analysis is that allowing the states where employers are located to tax remote work income is good policy. Two concepts support this conclusion: competitive neutrality and residence neutrality.

On the issue of competitive neutrality, taxing remote work at the employer’s location is superior. The basic idea of competitive neutrality is that tax should not matter in competition between resident and nonresident workers for a particular job. The focus here is on whether residents and nonresidents have the same incentives to work a particular job. Suppose that there is an employer based in Boston, MA. There are two remote workers who are competing for the same position at the employer. One is a remote worker who lives in Worcester, MA while the other lives in Nashua, NH, which famously has no income tax. If Massachusetts were unable to tax remote work based on the location of the employer that violates competitive neutrality. The New Hampshire remote worker would pay no tax while a Massachusetts based worker would. By changing to allow source taxation based on the employer’s location, it levels that playing field. Both are then subject to the same level of taxation. The idea is to look to where the taxpayers are competing for work, and that is the location of the employer.

Residence neutrality looks to ensure that tax does not affect in what jurisdiction people choose to live. The focus is about whether there is neutrality in a particular worker’s decision to physically live in the state where the employer is located. Take our Boston employer again. This time a particular worker is trying to decide whether to live in Worcester or Nashua. If the rules were that only the residence state of the worker could tax the labor income, then that distorts the decision, because moving to New Hampshire escapes taxes, while living in Massachusetts leads to full Massachusetts taxation. But if we allow taxation based on the employer’s location for remote work income, the decision is neutral. The remote worker pays Massachusetts tax regardless of whether they are in NH or MA.

Beyond these neutrality arguments, Holderness also strengthens the case on a few other dimensions. Moving to a residence-only system for remote workers is inequitable. Most work that can be remote is white-collar work. Jobs that cannot be remote tend to be lower-wage and held by people of lower socioeconomic stations and racial minorities. Keeping employer-location source taxation limits these inequities.

Holderness shows that the idea that the remote workers’ residence state provides more benefits to them than the employer’s state that the residency state should be the only one able to tax remote income is erroneous. First, the benefit principle is not an ordering rule. It is solely about if there is any right to tax something. The state where the employer is located provides significant benefits to the remote worker as well. After all, that state shapes and allows the operation of the labor market that the remote work. The amount of tax, though, is not keyed to amount of benefits provided or is taxing power only limited to a state that provides the most benefits. The amount of tax is instead related to other factors like ability to pay. Thus, those ordering rule ideas are misguided.

Second, this intuitive idea is wrong, because it ignores the reach of what the state where the remote worker resides can tax. The resident state can grab almost all the income of the remote worker, including income unrelated to remote work. The employer’s state, though, can only tax income connected to the out-of-state remote worker’s remote work income.

Finally, income is not the only tax base for the remote worker’s residence state. There are also consumption and property taxes that they can levy to cover the potential increased services that a remote worker uses. Additionally, they can impose user fees too. The source state cannot impose these other taxes or fees.

Holderness also notes that allowing employer source states to tax this income helps reduce some negative tax planning outcomes. If the residence of the remote worker was the sole determinant of taxing jurisdictions, it is relatively easy for workers to then locate in states with low income tax rates, thereby spurring a race to the bottom. Allowing source-based taxation related to the employer’s location makes this game harder. Both the remote worker and the business would have to locate themselves in states that impose no income tax on the remote worker’s labor income. That creates additional coordination concerns, and that makes the avoidance game and the race to the bottom a bit harder to achieve.

Holderness’s piece is welcome as a pushback against some of the knee-jerk reactions towards taxing remote work labor income. In making this case Holderness provides a well-developed policy defense of the regime that allows employer source states to tax remote income.

The piece raises some interesting questions too. For reasons of space and scope, Holderness does not discuss the idea of a fully remote virtual workplace. But there may be a time where this issue could be significant. What then is the employer’s location for source taxation? That question is one that, of course, has no answer yet. But Holderness’s piece, though raises a point that is important. For numerous reasons, we may still want to find some sort of proxy for the employer’s location and allow source-based taxation, because it implies that merely taxing based on the remote worker’s residence may be flawed even in a fully remote situation.

Here’s the rest of this week’s SSRN Tax Roundup:

• Gábor Hulkó (Széchenyi István University) and Michal Radvan (Masaryk University), Regulation of Public Finances in the Czech Republic in Light of Financial Constitutionality, Nagy, Z. (ed), Regulation of Public Finances in the Czech Republic in Light of Financial Constitutionality (posted Sept. 8, 2022).
• Joshua Blank (U.C. Irvine) and Leigh Osofsky (UNC Chapel Hill), Simplicity Lost, 20 Pitt. Tax Rev. ___ (2023) (forthcoming) (posted Sept. 8, 2022).
• Nyamagaga Gondwe (Wisconsin), The Tax-Invisible Labor Program: Care, Work, Kinship, and Income Security Programs in the IRC, 102 B.U.L. Rev. ___ (2022) (forthcoming) (posted Sept. 7, 2022).
• Jinyan Li (York University, Osgood Hall School of Law), The Misuse or Abuse Exception: The Role of Economic Substance, Arnold (ed.) The GAAR: Past, Present and Future (posted September 2, 2022).
• Young Ran (Christine) Kim (Cardozo) and Darien Shanske (U.C. Davis), State Digital Services Taxes: A Good and Permissible Idea (Despite What You Might Have Heard), 98 Notre Dame L. Rev. ___ (2022) (forthcoming) (posted Sept. 2, 2022).