united-states tax-law due-process
Are there legal limits to U.S. states taxing out-of-state income?
<p>When a New York State non-resident has NYS income, NY's tax rates are based NOT on the absolute amount of the NYS income, but on the non-resident's federal income, pro-rated to the percentage earned in NY.</p>
<p>For example, if the non-resident earns $5000 in NY, and $95,000 elsewhere, her tax is not based on a $5000 income, but rather, she pays 5% of the tax on a $100,000 income. In this example 5% is the percent earned in NY. The computation is on NY's form IT203, lines 31 to 46.   (I understand the progressive mindset behind this, and my question is not about whether it is fair or just).</p>
<p>My question: Are there constitutional limits on how aggressive a state could be in doing such things?   I'm surprised NYS can compel a non-resident to even disclose out of state income, let alone set a tax that is based on that entire income.   They are not formally &quot;taxing&quot; that other income .... but could they?   If I drive from New York to LA and pay tolls and sales taxes in every state along the way, establishing a very weak and dubious &quot;nexus&quot;, does every state become entitled to, say, impose an income tax on my entire global income?   Is there anything to stop states and local governments from setting taxes that accumulate to more than 100% of my income?</p>
<p><strong>A couple of straw man theories</strong></p>
<p>Perhaps an overly aggressive approach to taxing out of state revenue would intrude on the rights of Congress by having the side-effect of discouraging (therefore &quot;regulating&quot;) interstate commerce?  The NY approach to income tax (and apparently CA does the same thing) do not appear to have that effect.</p>
<p>Perhaps there is no constitutional limitation to what a state can do, but economics and politics regulates this?  If a state is overly aggressive, outsiders will cease to contribute to its economy, and the voters will respond.  So it can be self-regulating.   I'm skeptical, however, about whether 50 states would benevolently &quot;self regulate&quot; this way over 200 years.  If no state has ever attempted a wild non-resident money grab it must be because they cannot.</p>

<p>Both the <a href="https://www.law.cornell.edu/wex/due_process" rel="nofollow noreferrer">Due Process Clause</a> and the <a href="https://www.law.cornell.edu/wex/commerce_clause" rel="nofollow noreferrer">Dormant Commerce Clause</a> impose meaningful limits on states' ability to tax income on residents.</p>
<h2>The Due Process Clause requires &quot;minimum contacts&quot; between the state and the taxpayer.</h2>
<p>Under the Due Process Clause, states may only tax a nonresident's income when there is a &quot;some definite link, some minimum connection, between a state and the person, property or transaction it seeks to tax.” <a href="https://casetext.com/case/north-carolina-dept-of-revenue-v-kimberley-rice-kaestner-1992-family-trust/?PHONE_NUMBER_GROUP=C" rel="nofollow noreferrer"><em>North Carolina Dept. of Revenue v. Kimberley Rice Kaestner 1992 Family Trust</em>, 139 S. Ct. 2213, 2220 (2019)</a>.</p>
<p>Despite the word &quot;minimum,&quot; there isn't any fixed threshold at which contacts become sufficient to permit a state to impose a tax. Instead, the courts will ask whether the state's assertion of jurisdiction to tax the person offends &quot;traditional notions of fair play and substantial justice.&quot; A critical question in this analysis will be whether the taxpayer enjoyed the &quot;benefits and protection&quot; of the state in connection with the subject of the tax.</p>
<p>In your examples, then, you can probably guess how the courts would view each transaction.</p>
<ul>
<li>If you are a Connecticut resident but perform a $5,000 job in New York, you have physically entered New York, likely conducted business with another New York entity, and you can go to the New York courts if the other party breaches the contract by which you earned the money. You have meaningful contacts with the state and enjoy the protection of its laws, so the state is permitted to impose a tax on the income from that transaction.</li>
<li>But if you drive from New York to California, your presence in each state is likely highly transient. You pay tolls for using the highways and sales taxes for lunch or something, but you aren't generating any income from those transactions. Your presence in New Jersey would not, for instance, entitle you to go into New Jersey courts to sue for a breach of your New York contract. New Jersey has no meaningful connection to that income, so it may not tax it.</li>
<li>But contrast that with your lunch purchase, which creates sufficient connections to New Jersey to permit it to tax <em>that transaction</em>: you are physically in New Jersey, you are protected by New Jersey's food-safety laws, and you can go into New Jersey courts if Burger King intentionally poisons you. So the state can impose a sales tax on that transaction, but not income tax on out-of-state transactions.</li>
</ul>
<h2>The Dormant Commerce Clause prohibits states from imposing the &quot;unfair burden&quot; of double taxation on interstate commerce.</h2>
<p>The Dormant Commerce Clause prohibits the states from regulating, restricting, or substantially burdening interstate commerce without the consent of Congress.</p>
<p>The U.S. Supreme Court has made clear time and time again that income taxes violate the Dormant Commerce Clause when they create a risk of double taxation that doesn't exist for taxpayers with no out-of-state business:</p>
<ul>
<li><a href="https://casetext.com/case/adams-mfg-co-v-storen" rel="nofollow noreferrer"><em>Adams Mfg. Co. v. Storen</em>, 304 U.S. 307, 311 (1938)</a> (“Interstate commerce would thus be subjected to the risk of a double tax burden to which intrastate commerce is not exposed, and which the commerce clause forbids.”)</li>
<li><a href="https://casetext.com/case/gwin-etc-inc-v-henneford" rel="nofollow noreferrer"><em>Gwin, White &amp; Prince, Inc. v. Henneford</em>, 305 U.S. 434, 440 (1939)</a> (“Such a multiplication of state taxes, each measured by the volume of the commerce, would reestablish the barriers to interstate trade which it was the object of the commerce clause to remove.”)</li>
<li><a href="https://casetext.com/case/comptroller-of-md-v-wynne" rel="nofollow noreferrer"><em>Comptroller of the Treasury of Maryland</em>, 135 S. Ct. 1787, 1801-2 (2015)</a> (“The tax schemes held to be unconstitutional ... had the potential to result in the discriminatory double taxation of income earned out of state and created a powerful incentive to engage in intrastate rather than interstate economic activity.”)</li>
</ul>
<p>So even though New York and Connecticut have sufficient contacts from a due-process perspective to permit both of them to tax your business, they many not tax all of your income if not all of it if another state has a claim to it as well.</p>
<p>This has of course led to debates over exactly how much of your income New York and Connecticut is entitled to, and the question only gets more complex for businesses with larger footprints. Amazon, for instance, is doing business in every state and territory, so how do we divide its income among the 50+ entities looking to take a bite of those hundreds of billions of dollars in income?</p>
<p>For quite a long time, most states used a three-factor calculation that apportioned income among the states based on how much of they taxpayer's property, payroll, and sales were in each state. Oversimplified, this means that if you had 5 percent of your property in New York, 40 percent of your payroll in New York, and 15 percent of your sales in New York, that would average out to 20 percent, so you would pay New York taxes on 20 percent of your income.</p>
<p>Over time, the three-factor apportionment method has fallen out of favor, and many states adopted other methods -- especially calculations that more heavily weight the sales factor -- to encourage economic development. Because most large companies have only a small portion of their sales in almost any given state, they can substantially reduce their tax bills by setting up their headquarters in a state that is going to ignore the value of their real estate, equipment, and payroll when calculating their tax bills.</p>
<p><strong>tl;dr:</strong> Under the Due Process Clause, a state can't impose tax on anything it doesn't have some meaningful connection to. Under the Dormant Commerce Clause, the states have to find a way to make split up taxes that they might share a claim to.</p>
