Income tax scheme declared unconstitutional | TSLN.com

Income tax scheme declared unconstitutional

John Alan Cohan
Attorney at Law

A disturbing feature of American taxes is the way some states tax the income of its residents earned both within and outside the state, as well as income earned within the state by nonresidents. Carly Fiorina, former Hewlett-Packard CEO and now presidential candidate, filed 17 state income tax returns last year. Many Americans file multiple state income tax returns in states where they do not live or work, but where they own a business or have income-producing activities. Ordinarily, the home state will allow residents a credit on income taxes paid to other states.

Often horse owners, ranchers and farmers incur income in various states. For example, a racehorse that wins purses in California and in New York will realize income for the owners who reside in other states. A show horse being trained and then sold in another state will incur income for the nonresident owner. Income earned in multiple states by horse winnings can create a huge pile of state tax returns, even though you will usually get credit.

The way it works is that your home state taxes you on all your income; states where you don't live might tax you on the income you earned in those states. The home state usually will credit you back for income tax paid on income earned in other states, but not always.

The U.S. Supreme Court recently decided a case involving this feature of Maryland state taxes. [Comptroller of the Treasury of Maryland v. Wynne.] The case considered Maryland's policy to not offer its residents credit against the income taxes they pay to other states. This resulted in double taxation of income earned by Maryland residents outside the state. The Supreme Court considered the issue of multiple taxation by denying residents a credit on income taxes paid to other states. It held that Maryland's tax scheme violates the Commerce Clause.

Some states have bilateral agreements with other states. For example Virginia residents who earn income in Maryland pay tax only to Virginia, and vice versa.

States that have no income tax are: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming.

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The IRS has long had a program of sharing tax information with state taxing authorities. Thus, if you face a state audit, the state agency will have access to your federal tax returns. State agencies usually have computer links with the IRS. If you are audited by the IRS, your state may automatically find out.

Most state tax collectors operate similarly to the IRS. They may accept installment payments, levy assets, or settle tax bills. State agencies also provide appeal rights if you disagree with the results of an audit.

"Loose tongues sink ships" is a saying applicable to tax audits. What you say can and will be used against you. That's why it's prudent to have representation, especially if the tax liability at stake is significant.

If audited by state or federal authorities, it's crucial to have good documentary evidence to substantiate deductions and to show that your activity is conducted in a businesslike manner. Usually the auditor will issue a list of things wanted. Your representative may be able to whittle this down, and should only provide those documents requested as well as anything that may help show the strengths of your business model. In audits of horse, livestock and farming activities where there are losses, the auditor will be particularly skeptical, so that you would benefit from representation by someone experience in your particular industry.

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