The “Comedy” of State Sourcing and the Tax Code
In the campaign for Minnesota’s Senate seat in 2008, former SNL comedian Al Franken got tripped up by the tax code – and it wasn’t funny at all. Franken owed back taxes and penalties for multiple years, in 17 states, in the amount of $70,000.
For many this news was surprising. Franken had been on the national stage for over 40 years and people felt they knew him either through his comedy work on Saturday Night Live or his later career as a commentator and author. Avoiding taxes in 17 states made it seem that something devious was afoot.
The fact is, Franken’s mistake is a common one that many taxpayers make. It was only due to his political campaign that he finally realized his mistake – improper state sourcing.
Sports figures, entertainers and corporate executives travel the country doing business in multiple states. A single day of work in a state not their domicile, could make these taxpayers responsible for filing. If you find yourself working in multiple states in a given tax year, you have to be extremely careful how you characterize income and where you source it – or, like Franklin, you risk getting caught in a tax web.
What Kind Of Income Are You Earning?
First, you need to characterize income. In Franken’s case, he was getting paid fees for speaking engagements – which is compensation for services provided. As such, it is sourced to the state in which it was earned.
When taxpayers hear this, they worry that they’re about to be double taxed. Not so. Let’s use today’s rates to explain how Franken got in trouble. In our hypothetical example, assume Franken gave a speech in Kentucky and received $100,000 in speaker’s fees. Kentucky’s tax rate is 7% so Franken would have tax due to that state. But in Minnesota (his domicile), the top bracket is 9.85%. Thus, Franken would pay Kentucky the 7% due there. Kentucky would then give Minnesota a credit for the 7% tax paid and Franken would still be on the hook in his home state for the 2.85% difference between Kentucky and Minnesota state rates.
Ultimately, he pays only the amount that would have been due as a Minnesota taxpayer, but it is divided between the two states. That’s why when questioned on this, Franken pointed out (correctly) that he had paid the right amount, just to the wrong states.
Everyone’s Getting In On The Game
So if it is just an administrative issue between states, what’s the big deal? The big deal is revenue. States are aware that nonresidents come into their borders and generate income there. And they feel they have a right to the tax on that income.
It can be an aggressive game among states. For instance, in January 2013, the state of Georgia (apparently realizing that they were leaving money on the table by not collecting taxes) started requiring withholding for movie stars and their production companies filming in the state. While state sourcing has always been the rule, the impetus for the withholding law was the increase of Hollywood movies being filmed in the Peach State, thus a potential increase in tax revenue. And that also means a decrease in tax revenue for the resident state.
Further, states are benefiting from a plethora of publicly available data and the ease with which they can track an individual. From EZ – Pass to Social Media to a celebrity appearance, the states are looking for all sources of revenue. So if you are crossing state borders and receiving compensation for services provided, you should be on alert that you might have a state sourcing issue.
In The End
In his role on SNL, Franken often played Stuart Smalley, not a licensed therapist but a non-professional who drew on his own personal experience. When it comes to the complexities of multi-state taxes, it’s not enough to play a professional on TV. Franken took the right step in hiring a new tax firm familiar with these issues. They went back and amended his returns so that he filed correctly in each state. If you think you might be in that situation – it’s no joke. Head for your nearest tax professional to help make it right.