The U.S. Supreme Court is considering granting cert on a case that could impact Pennsylvania’s ability to collect income taxes from nonresidents and the city of Philadelphia’s ability to continue to apply its “requirement of employment” rule for the city’s wage tax. The U.S. Supreme Court has asked the acting solicitor general to weigh in on New Hampshire v. Massachusetts, a case in which New Hampshire is challenging Massachusetts’ practice of taxing nonresidents who previously worked in-state but now work remotely from home in New Hampshire. In filing the case, New Hampshire invoked the Supreme Court’s original jurisdiction, which allows states to sue one another when their sovereign interests are at stake.
Questions have been raised as to whether New Hampshire has standing to bring the suit. Assuming New Hampshire can pass the standing hurdle and the Supreme Court grants cert, the justices would be asked to determine whether Massachusetts’ rule is an unconstitutional violation of both the Dormant Commerce Clause and the Due Process Clause of the U.S. Constitution. New Hampshire argues that a state’s power to tax nonresidents is restricted; a state has no authority to “tax value earned outside its borders.” It goes on, income earned by a nonresident working outside of a given state is not and cannot constitutionally be subject to taxation by any state other than the state of residence of the individual.
How does this impact Pennsylvania—a state not a party to the litigation and not involved in or impacted by the Massachusetts taxing scheme? Five states, including Pennsylvania, tax non-residents on income earned while working out-of-state. Arkansas, Delaware, Nebraska and New York are the other states. Pennsylvania taxes those nonresidents, unless the non-resident’s employer obligates the individual to work out-of-state. (72 Pa. Statutes Section 7308; 61 Pa. Code Section 109.8.) Further, in light of Covid, the Pennsylvania Department of Revenue, consistent with Massachusetts’s approach, stated that non-residents working remotely would continue to have Pennsylvania source income for tax purposes. Thus, if the Supreme Court were to grant cert in New Hampshire v. Massachusetts, the decision could have a direct impact on Pennsylvania and its ability to tax non-residents working remotely.
However, the immediate affect would not be staggering because Pennsylvania maintains reciprocity agreements with a number of its neighboring states, thereby limiting the revenue derived from this policy. Pennsylvania has reciprocity agreements with Indiana, Maryland, New Jersey, Ohio, Virginia, and West Virginia. In fact, it’s possible that a decision in favor of New Hampshire could actually benefit Pennsylvania. Because there is no reciprocity agreement between Delaware and Pennsylvania, when a Pennsylvania resident works for a Delaware employer, that individual pays Delaware state tax and Pennsylvania state tax. Pennsylvania, the state of residence, grants a credit against the Pennsylvania tax for the tax paid to Delaware on those same wages. Because Delaware’s tax rate is higher than Pennsylvania’s, Pennsylvania does not receive any income tax from those individuals working in Delaware, but living in Pennsylvania. Assuming Pennsylvania and Delaware’s positions are invalidated, Delaware employees working remotely from their homes in Pennsylvania would not be subject to the Delaware tax for the time spent outside of Delaware. That means instead of Pennsylvania receiving $0 from that resident, it could instead receive positive tax revenue. However, as remote working becomes more the norm and people are able to work from almost anywhere, individuals may start moving to and working in states that are not neighboring states and with which Pennsylvania does not have reciprocity agreements. For instance, a remote worker may choose to move down to Florida or up to Connecticut—states that are not covered by Pennsylvania’s reciprocity agreements. Such a change in working habits coupled with an adverse decision in New Hampshire v. Massachusetts could impact Pennsylvania’s ability to collect tax in those situations.
But, the potential impact of the case stretches further within Pennsylvania—a grant of cert and decision in New Hampshire v. Massachusetts may also affect the city of Philadelphia. Philadelphia maintains a long-standing “requirement of employment” test to determine whether or not a non-resident is subject to the city’s wage tax. If a non-resident employee is required to work from home by their employer, that individual is not subject to the city’s wage tax. However, if a nonresident employee instead chooses to work from home, or has the option to work from home, that individual is subject to the wage tax—despite the fact that they were working outside of Philadelphia.
In light of the remote working environment brought about by Covid-19, Philadelphia has not deviated from its long-standing test—it has merely applied that test to the pandemic environment. Contrary to Pennsylvania, Philadelphia has taken a less aggressive approach for purposes of its wage tax. The city maintains that non-residents are eligible for a refund of the city’s wage tax for any period where the non-resident was required to work from home by his/her employer because of the pandemic. This has resulted in refund opportunities for a number of non-residents, since many businesses were shuttered for at least a few months of 2020, if not longer.
Similar to Pennsylvania, a decision in favor of New Hampshire may impact the city’s policy as it relates to out-of-state, non-residents working remotely for their convenience. To the extent the court determines that a state or locality cannot tax work performed outside of a jurisdiction, such a finding may call into question the city’s “requirement of employment” test.
With tax season on the horizon, many practitioners are questioning what position taxpayers should take on income and wage tax returns. If taxpayers take a filing position contrary to Pennsylvania or Philadelphia’s positions, they can expect an assessment and a lengthy court challenge—but such taxpayers would not encounter the standing issue presented in New Hampshire v. Massachusetts. Alternatively, in the event the Supreme Court grants cert and finds in favor of New Hampshire, taxpayers will have an opportunity to file refund claims. Many eyes will be on New Hampshire v. Massachusetts in the coming months as we wait for the Supreme Court to make a determination on whether to grant cert.
In today’s age, these “requirement of employment” positions have become a relic—a reminder of how work used to be accomplished and blind to the shifting remote atmosphere and the corresponding constitutional challenges. The pandemic has only heightened an already shifting work environment and pushed employees to learn to work remotely at a faster pace. If the issue is not resolved in New Hampshire v. Massachusetts, it is only a matter of time before it resurfaces.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Jennifer Karpchuk is the co-chair of the State and Local Tax (SALT) Controversy and Planning practice at Chamberlain Hrdlicka. She may be reached at firstname.lastname@example.org.
Bloomberg Tax Insights articles are written by experienced practitioners, academics, and policy experts discussing developments and current issues in taxation. To contribute, please contact us at TaxInsights@bloombergindustry.com.