By Dean Heyl & Robert Kerr
Despite somewhat sanguine predictions by several economists that the nation has begun its climb out of a historic financial crisis, for many states the light at the end of the economic tunnel might be a train. According to a recent report from the National Association of State Budget Officers and the National Governors Association, state fiscal conditions "have continued to worsen" and state revenues can be expected to behind lag a national economic recovery by one to three years. In fact, state tax collections dropped 10.7 percent in the third quarter of 2009 – the third consecutive quarter of double digit revenue decline, according to David Adkins, executive director of the Council of State Governments.
"States foresee fiscal year 2011, which starts for most states July 1, 2010, to be the most difficult to date, and few see fiscal year 2012 much better," the report said.
Recent Wall Street Journal articles have reported the states collectively are facing up to $180 billion in budget deficits in the next fiscal year. Many of them have already depleted their reserve funds and are now seeking federal funds to balance their budgets. California alone wants $6.9 billion in federal money.
Some states have gone so far as to use Internal Revenue Service information to pursue delinquent taxpayers. For example, Oklahoma and Ohio are mining IRS data for leads and some tax collectors are coordinating with other state agencies in sharing data about residents. Nebraska lawmakers are preparing to let the state post online the names of hundreds of taxpayers who owe $20,000 or more. Many states such as Rhode Island already have web pages listing the top delinquent taxpayers.
Additionally, a number of states are aggressively taxing the income earned within their borders by out-of-state high income individuals such as actors, professional athletes, and business consultants, even if those individuals work within the jurisdiction for a handful of days in any given year. However, there could be a backlash to these actions. "If everybody goes after everybody, nobody wins," said Arthur R. Rosen, a New York tax lawyer and partner at McDermott Will & Emery. "In this interstate war of 'you tax my rich guy and I tax your rich guy,' it's just a wash, a preposterous flurry of tax returns."
Tax Refunds Delayed
April 15 – a date the very mention of which sends shivers up the spines of taxpayers –caused even more frustration for many individuals this year as six states (Alabama, Hawaii, Idaho, Kansas, New York, and North Carolina) stated they may be holding on to tax refunds. Although most states typically issue refunds within thirty days, Hawaii's Department of Taxation, for example, stated some residents may not see state income tax refunds until the end of August.
Last year, California's historic deficit of more than $20 billion caused the state to delay payment of tax refunds in addition to issuing billions of dollars in IOUs to vendors and others who were owed money.
In the last few years, the California Legislature has repeatedly introduced independent contractor withholding proposals. However, California's own Franchise Tax Board has stated that "at a rate of two percent, almost seventy percent of independent contractors will be overwithheld and more than forty percent of the amounts withheld will be in excess of tax owed." Simply put, withholding schemes of this sort create a "sugar rush" of cash that eventually has to be paid back (with IOUs, possibly – see above). Withholding forces independent contractors to make interest free loans to the state. So far, the California Society of Enrolled Agents (CSEA) and other stakeholders have been successful in beating back withholding proposals, but the issue is expected to resurface.
In New York, the state Senate wasted no time in rebuffing Governor David Paterson when he released his plans this year to delay more than $500 million in personal income tax refunds and $200 million in corporate income tax refunds. "This is the taxpayers' money, not the governor's," said New York Senate Majority Conference Leader John L. Sampson.
"Delaying the payment of income tax refunds is unacceptable, especially when so many New Yorkers are financially strained," said New York Senate President Pro Tempore Malcolm A. Smith. "These are funds that were overpaid, and it is a dangerous precedent for the governor to propose throwing away a tax filing and return policy which has worked well for decades. New Yorkers deserve to receive these funds without delay."
Tax Amnesty Programs: A way to get people "on the grid" or a reward for tax dodgers?
Proponents of tax amnesty programs consider the programs to be necessary evils to bring in funds during economic downturns, while critics often view the programs as nothing more than gimmicks that punish tax compliant individuals. A fiscal note attached to an amnesty proposal in New Mexico may have summed up tax amnesty opponents' concerns best by stating, "[f]requent amnesty periods may indirectly communicate a message to taxpayers that they do not need to comply with the Tax Administration Act because, potentially, another amnesty period may be approved. It is not known how frequent is too frequent."
Many states have been aggressively implementing tax amnesty programs. Last year, states including Alabama, Arkansas, Connecticut, Delaware, Louisiana Maryland, Massachusetts, New Jersey, and Vermont either attempted or launched tax amnesty programs. New Jersey collected more than $725 million from its amnesty program. New Mexico, New York, and Pennsylvania are among the states that plan to launch tax amnesty programs in 2010.
The following jurisdictions already have ongoing voluntary disclosure programs for individuals and businesses that have not already been contacted by their respective departments of revenue: Connecticut, Florida, Idaho, Indiana, Minnesota, Missouri, North Carolina, Pennsylvania, South Carolina, South Dakota, Tennessee, Utah, Vermont, Washington, and Wisconsin, as well as the District of Columbia.
Tax Exemptions and Credits under Attack
Actor James Woods recently appeared before the Rhode Island House Finance Committee and said if the state eliminated its motion picture tax credit program, he would not be able to make a movie in the state and would have to consider going to one of the other thirty-nine states that currently offer a similar tax break. The elimination of the tax credit is part of Rhode Island Governor Donald Carcieri's 2010 budget proposal.
It is not just Rhode Island that is cutting tax breaks and credits. In Washington, Governor Christine Gregoire has introduced budget proposals that would eliminate more than a dozen tax exemptions from the state's business and occupation (B&O) tax. Additionally, legislation has been introduced in the state that has a strong "tag you're it" aspect in that legislation specifies that nexus for tax purposes continues for the four succeeding tax years even if the thresholds are not met in those years.
States Are Becoming More Aggressive in Attracting Businesses
In response to what he saw as his neighboring states' anti-business climates, Idaho Governor "Butch" Otter sent an open "love letter" to Washington- and Oregon-based businesses encouraging them to come to his state. The following are excerpts from his letter:
"Legislators in the state of Washington are talking about even bigger tax increases to tackle a budget deficit that figures to be as big as Idaho's entire state budget. Businesses in both states are like those in Idaho; they are facing the most challenging times in decades, and even incremental cost increases can mean the difference between surviving and closing up.
The problem in Oregon is that folks were convinced that state government was what needed to be shored up rather than the jobs and revenue-producing private sector for which state government is supposed to work. As a result, they're chasing some of their cash cows to the border. And I welcome those businesses with open arms."
Given the downward trend on state revenue collection and the upward pressure on state expenditures, enrolled agents should continue to anticipate revenue enhancers of every conceivable shape and size. Until state economies get back on track, and this won't occur in each state at the same time, we should expect to see more "last ditch" attempts at raising tax revenue. The National Association of Enrolled Agents (NAEA) reports on such efforts regularly in its newsletter, E@lert.
About the Authors:
Dean Heyl is an attorney and president of Heyl Consulting, a firm specializing in state government relations. He was previously a special assistant for a governor and a lobbyist for a state attorney general. He has been NAEA's state legislative counsel since 2004.
Robert Kerrhas served as NAEA's Senior Director, Government Relations since 2004. Prior to joining NAEA, Kerr worked on the Senate Finance Committee Oversight and Investigation staff, where he assisted the committee chairman in providing oversight to, among others, IRS, U.S. Postal Service Office of Inspector General, and General Services Administration. He also spent a dozen years in a variety of positions at IRS and is well-versed in a variety of tax administration issues. Kerr holds an MBA from Case Western Reserve University and a BA from Mount Union College.
Reprinted with permission from the NAEA