States scramble for tax revenue wherever they can find it

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Imagine your state tax collectors hard at work…reading the entertainment news as part of their job description. State tax authorities always have used the media to track the cross-state earnings of sports stars, celebrities, and other wealthy individuals whose actions are likely to appear in the news.

The effort mostly was limited to the rich and famous because of their visibility and because there was so much to gain. These days, armed with the long reach that modern technology enables, tax authorities no longer have to read Variety to find out who’s working in their jurisdictions.

Now they have the ability to go after the salesman who travels out of state for one day to pitch a deal, or a New York consultant who makes a presentation in Florida. With so many state budgets bleeding red ink, tax authorities are turning over every rock they can in search of unpaid taxes.

"The states are all hungry for revenue", Alan Clavette, a Connecticut accountant, told reporters. "We are certainly seeing states like New York and Connecticut looking more and more for executives and everyday taxpayers who may be spending time across the border."

But some state officials deny they are motivated by budget woes.

"We are just trying to make sure our tax laws are complied with", Richard D. Nicholson, commissioner of the Connecticut Department of Revenue Services told The New York Times. "That’s not driven by a need for revenue. If we’re doing more, it’s because of advances in technology. We can do analysis we could never do before with just paper."

Now states have greater resources to track people who may be working out of state, including:

  • Federal information from the Internal Revenue Service
  • Traffic tickets
  • Real estate transactions
  • Bids for government construction projects
  • Commercial license plates

This information is entered into computers where tax officials can find it and go after the state’s share of income tax. When they had to rely on the media, the effort outweighed the amount of taxes they might collect for all but the big fish.

James W. Wetzler, who is a former tax commissioner for New York State, told reporters that before the increased availability of information, tax officials maintained a sort of "don’t ask, don’t tell" approach for most taxpayers.

"We tried to preserve a reasonable balance", said Wetzler – who is now a director at Deloitte Tax. "We wanted to avoid imposing onerous burdens on people just for us to collect small amounts of revenue."

The burden

Although the burden is significant – to employers and employees – many believe the best enforcement would be to require companies to withhold the appropriate state taxes from employee paychecks or face penalties. The payroll manager from one major multi-state employer estimates that the need to report out-of-state earnings adds approximately 10 percent to the cost of each project. That’s no small price tag. But the alternative is to send in state auditors, which could result in penalties for companies that fail to report the out-of-state earnings.

Many Fortune 500 companies admit they have not been diligent about reporting out-of-state earnings. But they also acknowledge they are subjected to more payroll audits than in prior years. When that happens, one thing auditors may ask to see is the company’s travel logs. Among other things, they search for instances where an employee was reimbursed for out-of-state travel and then look to see if that employee had taxes for that state withheld.

As for the burden to employees, the time spent to report the out-of-state taxes might be bigger than the tax burden itself, especially since most states let you deduct income tax paid to other states.

At this point, only a few states are not yet chasing hard after cross-state income, which means those states that are aggressive stand to reap the greatest benefit. They are able to siphon revenue that would be paid to other states. But it won’t last, says Arthur R. Rosen, a New York tax attorney and partner at McDermott Will & Emery.

"Everybody goes after everybody; nobody wins. 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", Rosen told reporters.

But there is one guy right now who is ripe for the pickings by at least 30 states, according to The New York Times. Those are the states visited by President Barack Obama in 2009, and according to the White House, the president plans to only file taxes in his home state of Illinois.

State of the states

Income tax isn’t the only way states are trying to close the budget gaps that grow wider each year.TheWall Street Journal describes states as being in freefall and posts this chart showing details of state tax revenues and budgets. According to WSJ, California and New York legislators already have agreed on multi-billion dollar tax increases that started earlier this year, and at least 10 states are considering major increases, either in income or sales taxes: Arizona, Connecticut, Delaware, Illinois, Massachusetts, Minnesota, New Jersey, Oregon, Washington, and Wisconsin.

In Oregon, revenue has fallen so much that the hole just keeps getting deeper making efforts to backfill it seem futile.

"With the size of our budget gap, we are looking at a situation of closing down our courts, releasing prisoners, and cutting the school year by as much as a month", Rep. Peter Buckley, co-chairman of Oregon's joint Ways and Means Committee told the WSJ.

Last year the Associated Press reported that some states, including Minnesota, were considering changing their liquor laws as a way to replenish the coffers made barren by the recession. For example, several states ban the sale of liquor on Sundays. Lifting that ban should bring in a 5 to 8 percent tax increase, according to some tax authorities. Other states might raise alcohol taxes, and still others are considering allowing the sale of liquor on Election Day.

A couple of years ago, reported that some tax agencies were sending individuals tax bills that seemed to come out of the clear blue sky. The bills went to people who own small planes and reside in one state but visit another. They give the example of Steve Kahn, who lives, works, and houses his plane in Massachusetts. When he got a tax bill from Maine for a whopping $26,000, he thought it was a mistake. It wasn’t.

Kahn told reporters",At best what Maine is doing is underhanded and devious; at worst it is illegal", Kahn said. "Either way, it's wrong."

But tax officials from Maine say they are just enforcing existing state law by sending bills – some of which are in the six-figure range – to out-of-state plane owners. For airplanes, the law allows the state to collect a 5 percent use tax from people who did not pay sales taxes on their planes if the planes were brought to Maine for more than 20 days (not counting time for maintenance and alterations) in the first year of ownership.

"We're charged with administering the law", David Bauer, a tax policy analyst with Maine Revenue Services told "We didn't write it."

In the case of Maine, the use tax laws have been on the books for decades, but enforcement only began in the last few years.

Conditions improving reported in the closing days of March that there is good news for some state budgets. After a two-year downhill slide that left states with a $196 billion budget gap, revenues in the 15 largest states by population are starting to show some promise. For fiscal year 2011 they are forecasting an overall gain in tax revenue of 3.9 percent. For all 50 states, on the average there is reason to believe collections may increase by 3.5 percent, according to Mark Zandi, chief economist for Moody’s

Beleaguered California took in 3.9 percent more in tax revenue since December than officials projected in January. New York had an increase of $129 million over its forecasts through February.

Better revenues mean the pressure on state credit ratings will ease up a bit after the serious beating they’ve taken in recent months. Nobody is saying that state budgets are out of the woods… not by a long shot. Combined state budget gaps are still estimated at $180 billion in fiscal 2011 and $120 billion in fiscal 2012, according to the Center on Budget and Policy Priorities in Washington, DC.  On the other hand, this is the first good news state budget officials have heard in a long time, so it’s hard to blame them for crowing a little.

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