The United States of America is a federal republic composed of the state government and the local governments. These governments impose tax to their citizens at both levels. The tax levied range from income tax, property tax, sale tax, dividends, estates tax just to name a few. States tax their citizens differently with regards to the constitution and the public law therein. This paper will focus on how individuals and businesses are taxed by their respective states. It will discuss the ability of the federal government and the local government to tax the US citizens, residents and businesses. It will briefly discuss the legal perspective in taxing nonresident alien individuals and businesses entities on their US source income.
State and local taxation (SALT)
State and local taxes are excised on individuals and business on top of the federal government taxes. Each state and locality has its own tax laws that it enforces on its citizens and residents. The most common types of tax that small businesses are required to pay in states and localities are income taxes and employment taxes. Income taxes are payable to the state and the amount levied depends on the legal structure of the business. For example, in most states, when a company is a limited liability company, the company gets taxed independently from the owners while in sole proprietors, the company and the owners pay a single tax (small business administration, 2016).
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Employment taxes are imposed on business owners with employees. These taxes are in addition to whatever tax the company is legally expected to pay as the federal employment taxes. In the USA, business owners in all states are expected to pay ‘state workers’ compensation insurance’ and ‘employment insurance taxes’. In certain states or territories such as California, New Jersey and New York, businesses are expected to pay temporary disability insurance (SBA, 2016). In the United States, constitution provisions or statutes allow a state to:
Restrict the type of taxes they impose0
Limit the rates charged on individuals and businesses
Specify the property to be taxed and those that should not be taxed
How properties should be valued before taxation
Specify the tax calculations
The state also has the capability to limit the amount by which a local government increases or decreases its tax levies.
As much as the state has the ability to restrict what taxes they collect, they cannot expand their tax collection authority beyond the US Constitution specifications. Municipalities and other local governments are at times restricted in tax imposition unless explicitly authorized by the state government (CCH Federal Taxation, 2016).
Importance of state and local tax
Several tax classifications are used to levy tax on different commodities and entities in states and localities. These tax categories include; property tax, sales and excise taxes, licenses, income taxes and other taxes. In the country, sales and income taxes provided the highest percentage. In 2008, income and sales tax accounted for 88% of the total tax collected. Excise taxes are included in the sales tax and it comprises of the tax levied on tobacco, alcohol and gasoline. These goods are treated differently and their tax calculation is different from other taxable items (National Conference of State Legislatures, 2016).
Legal perspective
In the US, powers to impose taxes on citizens by states and local authorities are restricted by the state constitutions and statues. States and local authorities are not allowed to levy tax beyond the stipulations in the constitution. The constitution statuses several provisions restricting the power of state to impose tax which include commerce clause, first amendment, duty of tonnage prohibition, supremacy clause, privileges and immunities clause, equal protection clause, due process clause and import-export clause. Furthermore, these provisions restrict the taxation of US citizens and residents and out of states taxpayers.
Taxing out of state taxpayers
The taxation of an out of state individual is restricted by the US constitution, federal law and applicable state law. Under the federal law, The Public Law 86-272 and The Internet Tax Freedom Act restrict the taxation of the nonresidents in the states. Provisions in the US constitution that is the ‘due process clause’ and ‘commerce clause’ forbid a state from levying tax on a nonresident unless the nonresident has satisfactory connection to the state. Nexus is the presence or activity requirements within a state before the state taxes a nonresident. In constitutional requirements, the state can only exert taxation power on a nonresident when it bears fiscal relation to protection, opportunities and benefits provided by the state; in simple terms, has the state given anything to the nonresident for which it can ask for something in return (CCH Federal Taxation, 2016).
Before a state can be considered to have Nexus, physical presence of a nonresident in the state is mandatory. Physical presence is a requirement in the satisfaction of a commerce clause although it is not necessary to satisfy the due process clause; Quill Corporation v. North Dakota , 504 U.S. 298 (1992). The state government has since criticized this rule especially with the growth of Internet Commerce whereby the number of out of state vendors has increased and they are able to avoid state income taxation. In addition, the number of sales to state residents of which neither sales nor use tax can be imposed has increased tremendously (CCH Federal Taxation, 2016).
Other than the physical presence standard, attributional Nexus applies to nonresidents. The US Supreme Court has maintained this nexus when a person performs activities within a state on behalf of a person with no physical presence within the state if the activities performed are significantly associated with the out of state person’s ability to establish and maintain a market in the state; Tyler Pipe Industries v. Washington State Department of Revenue , 483 U.S. 232 (1987), (CCH Federal Taxation, 2016).
In addition to the attributional Nexus, the state acknowledges the affiliate Nexus which attributes one person’s physical presence within a state to someone with n physical presence within the state if the two people satisfy a common ownership requirement. This Nexus is almost identical to the attributional but they defer in specific standards. For example agency between resident and nonresident persons is mandatory for affiliate Nexus but it is not for attributional nexus (CCH Federal Taxation, 2016).
Due process clause
The Due Process Clause in the USA Constitution fourteenth amendment section one states that nobody should be deprived of life, liberty or property without due process of the law. Due process is a phrase meaning ‘fair procedures.’ This implies that state taxing powers are limited by the minimum connection between a state and the person, property or transaction that the state seeks to tax. However, the Supreme Court has also utilized this part of the fourteenth amendment to ban certain practices; for example, the Court has ruled that the due process clause defends rights that are not definitely listed in the constitution. Through incorporation, the Court has used the due process clause to extend the bill of rights to the states over time (Sagal, 2013).
Commerce clause
The Commerce Clause is a constitutional provision in Article 1, Section 8, Clause 3 in the United States Constitution and it states that the congress of the United State has power to regulate commerce with foreign nations, among the numerous states and with the Indian tribes. The commerce clause is often referred to with regards to the individual components such as the foreign commerce clause, the Indian commerce clause and the interstate commerce clause. The congress hasrepeatedly turned to commerce clause to justify exercising authority over the activities of states and their subjects leading to significant power squabbles between the federal government and the states.
In taxation, the commerce clause has been the chief constitution restriction on the states’ control over interstate business taxation. This clause prevents states from inconveniencing interstate commerce with a tax not abided by local commerce. Nevertheless, a state is permitted to tax interstate businesses for their fair portion of state costs for the benefits that the interstate business derived from its transactions in the state. A state tax may surpass a constitutional aggregation if: the activity taxed has a substantial nexus with the taking state, it is fairly dispensed, it does not discriminate against interstate commerce and it is fairly related to services provided by the state. When a state tax affects foreign commerce, it must not create multiple international taxations and it should also not impair federal uniformity in a location where federal uniformity is essential (CCH Federal Taxation, 2016).
Conclusion
Taxation is a very important subject in a country. A significant percentage of the gross domestic product of any country is made up of the taxes collected in the country. In the USA taxes fall heavily on the labor income than the capital income. Taxation does not have to be direct tax deducted by the government but may also be indirect such as divergent taxes, subsidies on certain forms of incomes and spending. For example, people expending on higher education are taxed almost as much as those in formal investments. Each level of the government in the country impose tax to its citizens in order to be able to fully or partially fund their projects. Therefore it is imperative for citizens and other nonresident taxpayers to promptly pay their tax to enable the country’s program run smoothly. However, individuals should learn their rights and know the taxation conditions in the country to enable fulfill their civic duties appropriately.
Reference
National Conference of State Legislatures (2016). Importance of Major State Taxes . Print. Retrieved On August 9, 2016 from www.ncsl.org/.../ ...
Sagal, P. (2013). Due Process, Equal Protection and Disenfranchisement. PBS: Constitution USA. www.pbs.org/tpt/constitution-usa-peter-sagal/equality/due-process-equal-protection-and-disenfranchisement/
Smith, E., Harmerlink P., and Hasselback., (2016). Multijurisdictional Taxation: International and State and Local Transactions. CCH Federal Taxation Comprehensive Topics. CCH Inc. Pg. 1-13
U.S. Small Business Administration. (2016). Determine Your State and Local Tax Obligations. Retrieved On August 9, 2016 from https://www.sba.gov/starting-business/filing-paying-taxes/determine-your-state-tax-obligations
