Interstate Tax Issues That Shouldn’t Be Neglected by Congress

Now that the U.S. House of Representatives has advanced a bipartisan tax package, it goes to the Senate, where consideration will take time. Passing the bill in its current form would be the fastest way to deliver tax relief to individuals and businesses, but should the Senate decide to amend the House bill, they should evaluate some key interstate tax issues for inclusion.

  • Set a minimum 30-day protection for interstate remote and mobile workers, where nonresidents have to be working in a state for more than 30 days before being subject to a state’s income tax filing and withholding obligations. Currently, most states technically require filing and even withholding of income tax from workers in the state for even one day of work. With most states giving full credits for taxes paid to other states, the result is a shell game with lots of additional compliance burdens and legal risk for taxpayers. The 30-day threshold is what states are now moving to, as we track in our annual Remote Obligations and Mobility (ROAM) Index. A 2021 version, the Mobile Workforce State Income Tax Simplification Act championed by Senators John Thune (R-SD) and Sherrod Brown (D-OH), earned unanimous support in the Senate in 2021, and similar versions passed the House by voice vote in 2012, 2015, and 2017.
     
  • Reduce compliance costs on interstate retailers by codifying and expanding minimum Wayfair protections. Over 50,000 businesses remain out of compliance with the Supreme Court’s 2018 Wayfair decision that approved state sales tax collection on internet-based transactions. The justices in Wayfair applauded a South Dakota bill for its simplifications for retailers: one-step state-level tax administration for all sales tax jurisdictions in the state, no retroactive collection, and membership in the Streamlined Sales & Use Tax Agreement to make definitions and administration uniform (as well as provide free tax compliance software). Some states have built on these minimum standards (Texas, for instance, offers one combined state-local tax rate as an option in lieu of collecting for every jurisdiction), while others have fallen short (for example, NTUF sued Louisiana until they enacted legislation to modify their system). In Wayfair, the Supreme Court said Congress could flesh out the minimum protections touched on in the case, and Congress can still take up that invitation. The Senate Finance Committee held a hearing in mid-2022 to gather ideas, many of which had bipartisan support.
     
  • Update taxpayer protections in the “temporary” Interstate Income Act of 1959 (P.L. 86-272). In response to a Supreme Court ruling expanding state tax powers over businesses that solicit orders in multiple states, Congress enacted P.L. 86-272 in 1959 to reverse that ruling, promising future permanent legislation to define what types of activities make a company “present” for state business tax purposes. That has yet to happen, and in the meantime, many states (such as New York, Minnesota, and briefly California and Massachusetts) have decided any presence - even virtual, such as having websites accessible from the internet - means they can impose business taxes. One fix could be the Business Activity Tax Simplification Act (BATSA), which would restrict business taxes to companies with property or employees in the state. Another fix could define specific activities as protected from establishing taxable nexus, such as selling digital goods, offering remote repairs or software updates, contracting with marketplace facilitators, or generally ensuring the term “solicitation of orders” is not read narrowly as some states are trying to do. Either approach would prevent confusing and overlapping state-by-state economic nexus standards.
     
  • Define uniform rules for which states get to tax digital transactions. If a taxpayer buys a digital song from a company based in California (and incorporated in Delaware), via their server in Utah, while at an airport in Illinois on their way back to their house in D.C., which state gets to impose sales tax on that transaction? If the decision is left up to each state to decide, they will all seek to tax it, catching the taxpayer in the middle of a very uncomfortable tug-of-war. Congress can set clear boundaries that prevent states from piling on multiple taxes. One version, the Digital Goods and Services Tax Fairness Act, has been sponsored by Senators John Thune (R-SD) and Ron Wyden (D-OR), with a House version passing committee in a bipartisan vote in 2015.
  • Give taxpayers access to federal courts. Three federal laws - the Anti-Injunction Act, Tax Injunction Act, and Declaratory Judgment Act - stop taxpayers from challenging in court any law that assesses, levies, or collects any tax, with some exceptions. However, the IRS and state tax authorities often argue that everything they do relates to assessment, levy, or collection, so therefore, their taxes and practices are insulated from any legal challenges. The IRS recently lost this argument 9-0 in the Supreme Court, but states still make it. So if a taxpayer has proof that a state tax violates a constitutional provision or a federal law such as the Internet Tax Freedom Act (ITFA), they nonetheless can’t even get their day in federal court. They often must pay the tax, claim a refund, and endure years of administrative process in state tribunals involving the same authorities who imposed the tax to begin with. Congress could modify these statutes to prohibit preliminary or temporary injunctions, but allow cases to be heard.

Scholars debate whether the U.S. Constitution’s Commerce Clause was originally meant to empower a broad scope of the federal government’s activities. But where those scholars all agree is that the Commerce Clause did empower Congress to protect the national economy with bright-line rules for state taxation of interstate commerce. As my colleagues Andrew Wilford and Tyler Martinez wrote recently:

This is necessary to keep states, particularly large ones, from overpowering smaller states and hurting citizens.

Because remote sellers cannot vote in every state they do business in, and given the tendency of states to export tax burdens and import tax revenues, only federal protection can discourage unfair taxation and excessive regulation of their trade. It is otherwise tempting to outlay taxes on those who have no vote or invent regulations that affect industries in other states. In other words, when taxpayers face taxation and regulation in states that they lack representation in, their elected representatives in the federal government must act to protect them from excessive burdens.[...]

Abusive economic nexus laws, where states impose burdensome taxes on those beyond their borders, stretch the bounds of federalism far more than federal action would. Constitutionally, states generally hold sway within their own borders. But outside their borders, state powers are far more restricted on matters of interstate commerce and the need to respect the laws and legal decisions of other states. In this sense, action by Congress to protect out-of-state businesses is in accordance with federalism rather than at odds with it.

The ideas presented above would protect the interstate economy and taxpayers, without unduly infringing on legitimate state tax powers. To that end, they would remove barriers to success and help many small businesses. Let’s hope they are not forgotten.