Common-Sense Solutions for COVID-19 State Tax Relief

Needless to say, the COVID-19 outbreak has placed a significant strain on businesses across the country. With declines in income and consumer spending, states are also expecting substantial declines in their own revenues, which can be especially difficult to address because of balanced budget restrictions.¹ To survive the outbreak and return to “normal” as soon as possible, states and taxpayers will need to cooperate more closely than ever before. While states that are inflexible with taxpayers may marginally reduce some short-term budget deficits, those states will likely be worse off in the long run as taxpayers relocate, reduce workforces, or, worse yet, go out of business. How states respond to COVID-19 over the coming months will undoubtedly play a large role in the economic health of local businesses and the workers they employ. At the same time, now more than ever, taxpayers must understand and anticipate state budgetary realities when seeking tax relief. Ultimately, both states and taxpayers will be better off if they can work together to immediately identify and enact practical solutions that provide meaningful short-term relief to taxpayers while avoiding significant long-term impacts to government budgets.

Fortunately, states have several of these kinds of options to assist taxpayers, and most states have already begun taking steps to provide tax relief. Nearly every state has extended filing and payment deadlines to correspond to the federal extensions. Moreover, to the extent they have not already done so, states should seriously consider conforming to the corporate income tax provisions of the federal Coronavirus Aid, Relief, and Economic Security (CARES) Act — especially the law’s net operating loss provisions, which provide much-needed immediate cash flow to businesses.²

States also have several opportunities unique to their own taxing systems that can provide much-needed economic relief to taxpayers without undermining their own budgetary needs. Those opportunities include changing apportionment formulas to encourage in-state employment and activity, delaying enforcement of marketplace facilitator rules or creating safe harbors for marketplace facilitators, ensuring taxpayers are not penalized based on work-from-home arrangements, eliminating or suspending taxes based on gross receipts or revenues, and allowing taxpayers entering voluntary disclosure agreements additional time to pay outstanding taxes. The rest of this article will discuss these common-sense solutions.

Change Apportionment Formulas That Rely Heavily on Payroll and Property Factors

Of course, jobs and unemployment are critical issues related to the COVID-19 outbreak for both businesses and state governments. States have clear interests — both fiscal and otherwise — to ensure that as many of their citizens as possible remain employed during and after this crisis. Even with federal relief, though, many employers are struggling to keep employees on their payrolls. Like the federal government, states have a role to play in limiting joblessness within their borders. To do so, states with corporate income tax apportionment formulas that heavily weight payroll or property factors can take the straightforward step of adopting single-sales-factor apportionment or allowing taxpayers to elect single-sales-factor apportionment.

Despite the recent trend toward single-sales-factor apportionment, many states’ standard apportionment formulas still heavily weight payroll and property factors.³ In those states, a company’s heavy in-state investment in employees or physical locations is usually penalized with a higher tax burden. In the current circumstances, this is exactly the opposite incentive states should be providing. Now more than ever, tax considerations should not pose an artificial barrier to employers keeping employees at work or just on the payroll, and employers should not be penalized for continuing to own in-state business locations that might not be profitable or even operating.

In the current climate, the most direct way for states to address this issue is to allow taxpayers to elect single-sales-factor apportionment, with a lock-in period of three to five years.⁴ This would remove penalties for retaining employees and brick-and-mortar locations and give many taxpayers needed short-term cash flow without unintentionally harming other taxpayers. Also, by locking in the election for several years, the long-term impact on states’ budgets would be minimized.

Some states may be concerned that allowing this election could cause large short-term reductions to their budgets. Needless to say, though, states often fine-tune their apportionment provisions to offer incentives to taxpayers to create or keep local jobs, and they have even more reason to do so now. That being said, to address the budgetary concerns and still encourage taxpayers to keep employees on their payrolls and to own brick-and-mortar locations, states could adopt single-sales-factor apportionment for all taxpayers.⁵

Alternatively, states could take a more targeted approach and allow only taxpayers qualifying for relief under the Paycheck Protection Program or other similar federal or state programs to elect single-sales-factor apportionment. As another targeted option, states could adopt rules excluding from the payroll factor’s numerator all wages subsidized by the Paycheck Protection Program or other similar measures. States could also use existing alternative apportionment statutes to allow for single-sales-factor apportionment when a taxpayer demonstrates that it has kept employees on its payroll or continued to own physical locations even though layoffs or closures would have made more economic sense. In those instances, payroll and property factors would arguably fail to reflect the economic reality of the taxpayer’s business.⁶ The most important thing is that states do not allow apportionment considerations to actually cause or encourage layoffs or the closure of business locations.

Adopt Rules Addressing the Sharp Increase in Working From Home

Though we do not yet have a clear picture of the long-term effects COVID-19 will have on the economy, it already seems obvious that the pandemic will have enormous impacts on telecommuting and working from home. Millions of workers who were previously coming into the office are now working from home, and work-from-home practices are likely to change significantly even after the pandemic is over. Regardless of the long-term effects, though, work-from-home arrangements have the potential to cause countless state tax compliance issues, especially regarding nexus and personal income tax liability and withholding. These issues can be particularly complicated as employees have often scattered across the country to quarantine with family.

To address these issues, states should immediately adopt legislation or regulations that preserve the status quo by clarifying that an employee’s and employer’s personal income tax or withholding obligations continue to exist only in states where the employee had income tax liability before the COVID-19 outbreak and that employees working remotely will not, alone, create nexus for employers. Adopting these rules will benefit taxpayers by reducing compliance burdens on individuals and employers who have more pressing issues to address, and will benefit states by helping to avoid unexpected and unintended reductions in revenue.

Some states have led the way on adopting personal income tax rules to address the recent substantial increase in the number of people working from home, but these rules still leave a lot to be desired. For example, Massachusetts has adopted rules clarifying that the income of employees who worked in Massachusetts before the COVID-19 outbreak but who now work from home because of the outbreak will be treated as Massachusetts income for purposes of personal income tax and withholding.⁷ Likewise, an employee suddenly working in Massachusetts because of the COVID-19 outbreak will not be required to pay Massachusetts personal income tax — and his or her employer will not be required to withhold the tax — to the extent there is personal income tax liability in another state.⁸

While rules like Massachusetts’s generally preserve the pre-COVID-19 status quo, they could — and should — go further. Consider, for example, a company located in a state without a personal income tax that allowed its employees to work from home in response to the outbreak. If one of the company’s employees decided to travel to Massachusetts to quarantine with family, the company may still be responsible for withholding Massachusetts personal income tax, even though the company may not have known exactly where the employee was working. Instead of going only halfway, states should truly preserve the status quo by clarifying that there is no personal income tax liability or withholding responsibility solely because an individual works while quarantined in a state.

Perhaps more importantly, some states have clarified that a company will not have nexus for corporate income tax purposes merely because the company’s employee happens to be working in the state because of the COVID-19 outbreak.⁹ Obviously, this common-sense measure avoids countless tax compliance nightmares as employees work from home. States should adopt similar common-sense measures, but again, they should go further to include sales tax and other types of taxes as well.¹⁰ There is no reason that these nexus rules should be limited only to corporate income tax.

Postpone Enforcement of Marketplace Facilitator Rules or Adopt Clear Safe Harbors

Following the Supreme Court’s decision in Wayfair,¹¹ most states have, in addition to adopting economic nexus, enacted marketplace facilitator rules, but some of these rules have not yet — or have only recently — gone into effect.¹² For example, Tennessee recently passed legislation requiring marketplace facilitators to collect and remit sales tax beginning October 1, 2020. Marketplace facilitator rules primarily affect taxpayers that are currently experiencing a multitude of business, logistical, and technical problems resulting from increased online shopping by people seeking to avoid public places where COVID-19 could be transmitted. States should be thoughtful about when and how they enforce their marketplace facilitator rules, especially when those rules are new.

From the perspective of taxpayers, states with newly enacted marketplace facilitator rules should preserve the status quo and postpone enforcement of those rules until the COVID-19 pandemic has stabilized. It makes little sense to pile on new tax and compliance burdens right now. Even without a pandemic, it is difficult for marketplace facilitators — which often have limited knowledge of the exact nature of the transactions at issue — to ensure they are collecting and remitting sales tax correctly. COVID-19 only makes those difficulties greater.

From a state’s perspective, though, completely delaying enforcement of marketplace facilitator rules may be untenable. As more purchasers move online to avoid leaving their homes, states likely view marketplace facilitator rules as a critical component of minimizing the impact of COVID-19 on state budgets. As a compromise, states should at least adopt clear and simple safe harbors that allow marketplace facilitators to avoid liability by taking reasonable steps to collect and remit sales tax based on a customer’s mailing address and a table of rates that correspond to ZIP codes — or an open-access database of tax rates for individual addresses. These safe harbors should also make clear, to the extent state law does not already do so, that neither marketplace sellers nor their customers can sue a marketplace facilitator (through a class action or otherwise) for collecting sales tax consistent with the state-approved tables or database.

Eliminate or Suspend Taxes on Gross Receipts or Revenue Rather Than Income

Either in addition to or as a replacement for corporate income tax, several states levy taxes on gross receipts or revenues rather than income. Oregon’s corporate activity tax, Tennessee’s business tax, Texas’s margin tax, and Washington’s business and occupation tax are all examples. In the best of times, these taxes are suspect from a policy perspective. Gross receipts and similar taxes are often confusing and difficult to comply with, undermine transparency and neutrality, distort market activity, and tend to heavily tax business inputs.¹³ Also, and of particular significance in the current circumstances, gross receipts taxes are imposed regardless of whether a business is profitable.¹⁴ As a result, gross receipts taxes are particularly bad in times of crisis because they pour additional burdens onto companies already experiencing financial strain.

With many companies experiencing substantial losses because of COVID-19, there is very little justification for continuing to tax them regardless of whether they are profitable. Ideally, states will take this opportunity to eliminate gross receipts and similar taxes, benefiting distressed taxpayers in the short term and, in the long term, making their tax systems more fundamentally sound. At a minimum, states could suspend enforcement of gross receipts and similar taxes, either for all taxpayers or for those experiencing significant financial hardship because of COVID-19.

Of course, states have legitimate budgetary concerns that eliminating or suspending an entire tax is not possible. The best way to address these concerns is not continuing to impose deeply flawed gross receipts taxes. Instead, states that cannot otherwise afford to eliminate or suspend these taxes could adopt modest corporate income tax rate increases to offset the lost revenue from gross receipts taxes. This would more fairly distribute tax burdens and increase the likelihood that more companies will be in business after the pandemic is resolved.

Allow Extended Payment Plans for Voluntary Disclosure Agreements

Before the COVID-19 pandemic, often the best option for a taxpayer with outstanding state tax liability was to enter into a voluntary disclosure agreement with a state. The agreement provided the taxpayer with the benefit of limiting its liability to a specified lookback period and, generally, eliminated or reduced penalties or interest that would otherwise be imposed.¹⁵ The state also benefited by having more taxpayers become compliant without the need for an audit or use of any other administrative resource. For these programs to continue to serve their intended purpose and benefit both states and taxpayers, states need to respond to the realities taxpayers are facing by being flexible with the terms of their voluntary disclosure agreements, especially by allowing taxpayers a longer period to pay back taxes.

Under the standard terms of voluntary disclosure agreements, taxpayers must pay outstanding taxes within a few months of entering the agreement. Now, reduced cash flow caused by the COVID-19 pandemic makes this arrangement unworkable for many taxpayers with significant potential liability. As a result, taxpayers that would otherwise be inclined to enter an agreement may choose to wait and see if they get audited — a process that could effectively delay payment for several years and impose significantly more taxes on the taxpayer.

Many states have responded to this situation by informally announcing that they will consider allowing payment plans as part of their voluntary disclosure agreements, typically on a case-by-case basis.¹⁶ A few states, including Florida, Georgia, Iowa, New Mexico, Washington, and Wisconsin, already allow payment plans, but the terms of these plans vary widely, and participation in a payment plan can result in a taxpayer losing protection from interest or penalties.¹⁷

States should be more aggressive in these efforts and strongly consider offering extended voluntary disclosure agreement payment plans as a matter of course. Sixty months is likely a good benchmark that would allow taxpayers with significant liability a long enough window to make payments and still allow the states to receive the revenue they need to operate. To the extent permitted by law, states should also ensure that entering a payment plan will not eliminate core benefits such as penalty or interest waivers. Finally, states should publicly notify taxpayers that an extended payment plan is an option under their voluntary disclosure programs and explicitly identify the terms and conditions on which such plans are available.

Conclusion

We are at a crossroads. States’ and taxpayers’ responses to the COVID-19 pandemic will determine the economic future of local businesses, citizens, and each state. If that future is to be bright, states and taxpayers need to work together to figure out workable solutions to the problems the pandemic has created or exposed. This article suggests several common-sense options, but there are undoubtedly many others. To find these solutions, taxpayers need to understand and accept the realities of state budgets, and states need to be flexible and proactive to ensure that meaningful relief is provided to taxpayers when they need it most — that is, right now. States that quickly, reasonably, and thoroughly respond to the tax issues created by COVID-19 will almost certainly fare better in the long run than those that take a wait-and-see approach or retreat to familiar entrenched positions. Ultimately, thoughtful and timely state tax relief, achieved through the cooperation of states and taxpayers, will benefit everyone.