Over the past few years, state and local governments have received a financial boost from federal aid related to the COVID-19 pandemic and surprisingly robust tax revenues. However, some jurisdictions are still searching for new sources of revenue. Two potential targets that have emerged are wealthy taxpayers and telecommuters with an employer located in a different state.

Millionaire Taxes

New taxes on high earners are likely to be considered in a number of states in 2023. In the November 2022 elections, voters in California and Massachusetts were asked to decide if millionaires in their states should be taxed more. Voters in California rejected Proposition 30, which called for a 1.75% surtax on income above $2 million to fund incentives to buy electric cars and build charging stations.

However, voters in Massachusetts approved Question 1, which adds a 4% surtax for households making at least $1 million. The new levy, which aims to fund public infrastructure, is on top of the state's 5% flat-rate income tax. See this Tax Release for information on the state's new millionaire's tax.

Instead of imposing a new tax on high earners, voters in Colorado approved Proposition FF, which limits income tax deductions for those earning $300,000 or more beginning with tax year 2023. Joint filers are limited to deducting $16,000 (from $60,000), and single filers are limited to deducting $12,000 (from $30,000). Colorado voters also approved Proposition 121, which reduces the state income tax rate to 4.40% from 4.55%.

Washington State's 7% capital gains tax took effect on January 1, 2022, but in March 2022, a Washington court found that the tax violated state constitutional provisions prohibiting the imposition of an income tax. In November 2022, the Washington Supreme Court stayed the lower court's ruling until it resolves the issues surrounding the levy's constitutionality. In the meantime, the Washington Department of Revenue announced that it is set to release an online system for taxpayers to report and pay the tax.

The tax is imposed on individuals, including those who are beneficial owners of a qualifying asset held by a pass-through entity or trust. To be subject to the tax, an individual must have annual Washington capital gains in excess of $250,000. Deductions are available for charitable donations and qualified family-owned businesses. The sale or exchange of certain types of assets is excluded from the tax. These include transactions involving real estate, assets held in retirement accounts, and certain transactions involving livestock.

The Mansion Tax

Tax laws aimed at the wealthy extend beyond levies on income and capital gains. There is a growing trend in California to raise city transfer taxes on multimillion dollar properties. On November 8, 2022, voters in Los Angeles approved Proposition ULA, or the so-called Mansion Tax, which imposes a 4% transfer tax on the seller of residential or commercial property in the city of Los Angeles valued at more than $5 million, but less than $10 million. The tax rate rises to 5.5% for properties valued at $10 million and above. These thresholds will be adjusted for inflation each year.

The tax, which is formally known as the Homelessness and Housing Solutions Tax, applies to real property sales occurring on or after April 1, 2023. The levy is an additional transfer tax and does not replace or modify existing Los Angeles county or city transfer taxes.

The new tax applies to the entire value of the sale, with no reduction for existing debt at the time of sale. It is imposed regardless of whether the property is sold at a gain or loss. An exemption from the levy applies to transfers to certain tax-exempt or governmental entities.

Taxes on Telecommuters

One outcome of the COVID-19 pandemic is that telecommuting or remote work arrangements have evolved from a growing trend to the norm at many companies. Unfortunately, a minority of states' tax laws are out of sync with the times and subject some telecommuters to double taxation.

Generally, states will tax income that is earned within their borders. However, a growing minority of states (currently Connecticut, New York, Pennsylvania, Arkansas, Delaware, and Nebraska) utilize convenience of the employer (COE) rules to determine how nonresident employees with remote work arrangements should be taxed on their income. Massachusetts temporarily applied the COE rule during the COVID-19 pandemic. New Jersey, while not having a formal statute or regulations, has also applied COE rules on audit.

The COE rule extends the reach of a state's taxing jurisdiction beyond its borders to include income earned by out-of-state employees of in-state businesses. The rule comes into effect if the employee works from a home in another state for their own convenience rather than the employer's necessity. Such compensation is treated as earned and taxable at the employer's location rather than the location of the employee. See this Tax Release for more information on COE rules.

Legal skirmishes and retaliatory legislation have erupted between states employing a COE rule and neighboring jurisdictions. When Massachusetts adopted an emergency regulation imposing a COE rule in 2021, New Hampshire challenged it in the U.S. Supreme Court. However, the high court denied New Hampshire's lawsuit. Although the Granite State's lawsuit was dismissed, it is likely a sign of future battles to come.

In December 2022, a bipartisan bill (S-3128) advanced in New Jersey that would impose its own COE rule in retaliation against New York's long-standing use of the rule. Pennsylvania proposed legislation (SB 1315) last year that would allow residents to work from home for an out-of-state employer for up to half the year without subjecting their employer to Pennsylvania's corporate tax. Presumably, under the measure, an employee working in Pennsylvania for more than half the year would be enough to trigger the state's corporate tax on an out-of-state employer that otherwise would not be subject to the levy.

The Takeaway

Two potential targets for states looking for new sources of revenue in 2023 are levies aimed at wealthy taxpayers and COE policies that ensnare telecommuters working for an employer located in a different state. Contact a member of Andersen's SALT team for information on how one or both of these trends may impact your tax planning.