Potential State Employment Tax Implications of a Post-Loper Landscape

By Ingrid Chawla 

Over the weeks since the Loper Bright ruling, tax and legal professionals looking for potential ramifications of the ruling in the employment space have explored the impacts at the federal level. While the bulk of the effects of this historical ruling will primarily play out in federal courts, some trickle-down effects are likely to change the state employment law landscape as well.

To learn more, Checkpoint Payroll sat down with James Creech, Senior Manager at Baker Tilly, to discuss state-level issues surrounding the decision and the possible impacts of the ruling on state agencies in particular.

Background.

As discussed previously, Loper Bright Enterprises v. Raimondo overturns the precedential deference to federal agency interpretations under Chevron, specifically when the interpretation attempts to reconcile ambiguous statute directives. In the wake of Loper Bright, courts must operate under “independent judgment,” deciding the outcome based on their own readings of existing statute, regardless of agency interpretation, even if the interpretation directly answers the challenge issued.

Similarly, many states follow the so-called Chevron doctrine exactly, and will now have to reformulate how challenges to existing statute proceed. While it is true that state agencies see no immediate impacts to their abilities to issue regulations, the possibility for interstate challenge in federal courts calls certain employment law issues into question. Additionally, overturned precedence based on industry interpretation at a District Court level may apply to certain groupings of states and not others that fall outside of their jurisdictions. According to Creech, taxation of labor is “going to be a very hot area going forward,” with a lack of uniformity lending itself to grey areas where legal interpretation based on existing statute will be both very difficult and ripe for challenge.

Worker classification.

One area Creech sees as a potential contention-point is worker classification. In states like California, which “has never met an independent contractor,” businesses must exercise extreme caution when classifying and paying their employees. Looking at this issue in the post-Loper world, employers with workers in multiple states, or with workers in states that used to follow the Chevron doctrine, may decide to treat more workers as employees so as to avoid the potential compliance ramifications of not paying people certain benefits on a state-by-state basis.

All in all, Creech laments that worker classification rulings may fall victim to “ad hoc taxpayer-by-taxpayer interpretations” that do little to provide either employers or workers with concrete or universal interpretation that would apply across the board. Additionally, this places more pressure on advisory professionals who want to provide definitive answers but may be required to lean into the nuance that the limited statutes present in some states require. “If I have to give a client an ‘it depends’ answer, I know they’ll be unhappy,” and many legislators shy away from the responsibility of providing certainty when they could have previously pushed it off on state agencies to provide interpretation or clarification.

Remote work and more.

The second very prevalent possible battleground between state employment laws revolves around remote work and employment taxation. Taxation of labor “is a very zero-sum game,” says Creech, in the sense that there’s only a certain amount of tax that can be collected, usually at the highest marginal rate of the highest taxing jurisdiction. So the question becomes “how is that allocated and what are the rules around collecting the tax?”

Because these questions are so complex, according to Creech, many states have chosen not to weigh in on the question at all whereas others prove more aggressive. For example, in states that “benefi[t] from people moving out of high-tax environments and spending sales tax dollars in [the] state doing remote work, [they] may not be so eager to maximize employment tax revenue” at the cost of those other benefits. Whereas in states like “New York and California, the states where the services are no longer provided,…there’s an argument for [rules like] the convenience of the employer rule.”

Although there is a risk for increased interstate litigation, the other issue is the standing that each individual taxpayer may have for remote work taxation and other wage and hour disputes, such as overtime pay or other benefits. “I think we’re going to see it in the traditional kind of hot areas, maybe with charitable contributions and some of the limitations that are imposed on by the regs in terms of substantiation and what constitutes substantial compliance with the regulations.” In these situations, the previous reliance on agency guidance that lent clarity to ambiguous statute may require more hands-on effort by legal professionals on a case-by-case basis. Though Creech believes the future impacts may not be so broad right away. “I think we may just have to wait and see with a lot of this stuff…I think we’re going to see this in the high dollar area first…where people have the resources to fight this.”

Impacts on state agencies.

The possibility that state agencies willingness to issue specific guidance to clarify employment law questions due to the potential for nullification in court poses a real problem, according to Creech. “[T]he thing I’m worried about more than anything else in this decision is that we’re not going to get the same kind of guidance. We’re not going to get the same kind of reliance factor because the agencies are going to say, ‘if I spend thousands of hours and scarce resources to have this set aside, then they’re just being wasted.'”

If this happens,  challenges will be “subject to the whims of any number of District Court judges and at the end there’s a taxpayer who’s going to be disadvantaged and have to demonstrate standing to show that they’ve been harmed by the interpretation.” Additionally, relying on state legislatures to pass clarifying laws may be untenable as well, as legislators are “worried about running for reelection” and are used to relying on tax experts at state agencies without similar career longevity concerns.

While the situation may appear overly complex and therefore foreboding, Creech says, it is likely not as bad as it seems. “Humans are adaptable,…we’ll find the new middle ground on how we’re going to operate in this environment. In all fairness, the Chevron standard was tricky too,” forcing taxpayers, legislators, advisory professionals, and the judicial system to adapt.

Future developments.

As Creech says, developments on the federal legislative horizon show that some clarification efforts are underway. As mentioned previously in Payroll Update, several lawmakers spearheaded an effort to codify the Chevron doctrine last month, while court challenges to the controversial Overtime Rule serve as an example of how future legal battles may play out at a federal level.