Let’s say you work from home, and your employer is located in another state. Which state has the authority to tax your income?
The legal status quo may surprise you: possibly both of them.
Several states, most famously New York, tax people who hardly ever set foot there — so long as they are working elsewhere for their own convenience, and not because their in-state employers assigned them to another location — and these states have gotten away with it for years. More recently, in response to the COVID-19 pandemic, Massachusetts enacted a similar rule as an emergency measure: It shut down many businesses and encouraged people to work from home, but demanded everyone keep paying their Massachusetts taxes, even if they had begun working in another state.
This is a shocking overreach, especially in the states that do it as a matter of routine, and it’s one that’s becoming more salient as remote work grows in popularity. States have no right to tax people as they work elsewhere, live elsewhere, and use government benefits and services elsewhere. And in a new case, the Supreme Court has a chance to do something about it.
New Hampshire is suing Massachusetts, arguing that the Bay State has infringed the Granite State’s right to live free or die within its own borders. New Hampshire prides itself on not having an income tax, but work accomplished in New Hampshire now can be taxed if it’s done remotely for a Massachusetts business. This both violates the state’s sovereignty and cuts into its residents’ finances, which is to say the state’s tax base.
There’s a boring procedural hurdle that may stop the Court from getting involved right away, more about which in a bit. But these blatant money grabs need to die, whether at the Supreme Court now, at the Supreme Court later, or through legislation passed in Congress.
The Constitution says Congress may “regulate Commerce . . . among the several States.” This gives the federal legislature broad authority to set the rules in these situations. However, Congress tends to regulate everything except what the Constitution tells it to, so it’s made little effort to resolve this issue. No bill on the matter has even gotten a committee hearing.
That’s where things get complicated, because when Congress fails to act, it falls to the courts to decide how much the Constitution allows the states to get away with — and the courts often struggle to do this or change their minds over time.
Essentially, courts make a subjective judgment about how strong of a connection there is between a state and the activity it’s trying to tax. They do this both under the due-process clause, because states lack a right to govern matters outside their borders, and under the “dormant commerce clause” — the idea that, since Congress is given the authority to regulate interstate commerce, states are at least somewhat limited in their ability to do the same, even if Congress hasn’t acted.
Courts have enunciated a variety of principles over the years. But among the most directly applicable, as New Hampshire points out, is the “Complete Auto test” (referring to a 1977 Supreme Court case). It has four parts: A tax is okay if it’s “applied to an interstate activity . . . with a substantial nexus with the taxing State, is fairly apportioned, does not discriminate against interstate commerce, and is fairly related to the services provided by the State.” The Massachusetts rule quite arguably flunks all four prongs.
The fact that an employer is located in Massachusetts isn’t enough of a nexus to the actual work being taxed, which occurs entirely in New Hampshire, and neither is the fact that the work used to be done in Massachusetts before the pandemic. Even if Massachusetts can apply some tax to this activity, requiring these folks to pay full income taxes can’t possibly be a fair apportionment — which, per a 1989 case, should reflect “the in-state component of the activity being taxed.” There’s discrimination against interstate commerce because people who work in New Hampshire are taxed more heavily if their employers happen to be in Massachusetts. And people who never even go to Massachusetts do not receive basic services from the state, though, as Massachusetts points out, the workers in question do receive protections from employment law and unemployment benefits. (Generally, though, employees collect unemployment from the state where their work is done.)
On top of all that, many of these laws are just awful policy. There are some mitigating circumstances to the Massachusetts rule: It avoids forcing employers to rejigger their tax-withholding practices to account for remote work during the pandemic, for example, and the state gives a credit for taxes that workers pay to their home states. States such as New York, by contrast, force workers’ home states, especially those that levy their own income taxes, into an unfair conundrum: They can give their residents a credit for taxes paid to other states — which diverts these workers’ tax dollars to states that don’t provide them services — or force the workers to pay two state income taxes on the same income.
Someone, whether it’s the Supreme Court or Congress, needs to fix this. Speaking of which, back to that boring procedural hurdle.
When one state sues another, the case falls under the Supreme Court’s “original jurisdiction,” meaning the Court handles the case directly, without waiting for lower courts to rule first. However, the Court might decide this matter isn’t appropriate for a state-vs.-state lawsuit. The issue, basically, turns on whether New Hampshire is genuinely defending its own interests as a state, or whether it’s simply litigating on behalf of its residents and using the Court’s original jurisdiction to jump to the front of the line.
If the Court bows out, it could take a long time to resolve the issue, because a taxpayer would need to challenge his tax bill in the state taxing him, through several levels of review, before appealing to the high court. More than once, the Court has simply refused to hear these cases after all that.
Ideally, Congress would step up and set the rules here, as the legislature is best situated to make the subjective judgment calls that need to be made. It could make some exceptions related to the pandemic, for example, while generally barring states from taxing the work nonresidents do at home — which after all is the policy the vast majority of states already follow. But if Congress won’t act, the Supreme Court needs to stop ducking the issue.