United States: SCOTUS invites Acting Solicitor General to weigh in ongoing dispute between Massachusetts and New Hampshire regarding controversial COVID-19 sourcing rule

In brief

In a 25 January 2021 Order, the Supreme Court of the United States invited the Acting Solicitor General to file a brief in New Hampshire v. Massachusetts (concerning the dispute between the two states regarding Massachusetts' COVID-19 personal income tax sourcing regulation) to “express[ ] the views of the United States” in the matter.


New Hampshire commenced the lawsuit last year, asking the Supreme Court to exercise its original jurisdiction to enjoin Massachusetts from enforcing its controversial personal income tax sourcing regulation (830 CMR 62.5A.3: Massachusetts Source Income of Non-Residents Telecommuting due to the COVID-19 Pandemic (“COVID Sourcing Regulation”)), which requires any nonresident of Massachusetts who works for a Massachusetts employer but is telecommuting because of the COVID-19 pandemic to source her wage income to Massachusetts as if she is physically working in the state. This was a change from the state’s prior rule that sourced nonresidents’ income based only on days physically worked in the state.  The rule is effective through 90 days after the date on which the Massachusetts Governor gives notice that the Massachusetts COVID-19 state of emergency is no longer in effect.

While the Supreme Court has historically declined to review similar tax disputes, the controversy has cast a spotlight on similar sourcing rules employed by other states in light of the country’s increased reliance on work-from-home arrangements brought about by the global COVID-19 pandemic.

The COVID Sourcing Regulation

On 21 April 2020, the Massachusetts Department of Revenue promulgated the COVID Sourcing Regulation as an emergency regulation, setting forth the sourcing rules that would apply to income earned by a nonresident employee who telecommutes on behalf of an in-state business from a location outside of Massachusetts.  Pursuant to the COVID Sourcing Regulation, "all compensation received for personal services performed by a non-resident who, immediately prior to the Massachusetts COVID-19 state of emergency, was an employee engaged in performing such services in Massachusetts, and who during such emergency is performing such services from a location outside Massachusetts due solely to the Massachusetts COVID-19 state of emergency, will continue to be treated as Massachusetts source income subject to [Massachusetts] personal income tax."

Thus, employees working in Massachusetts before the pandemic forced them to work from home are treated as if they are still working in Massachusetts during the pandemic. 

Like most states that impose a personal income tax, Massachusetts taxes nonresidents only on their Massachusetts source income.  With respect to wage income, the Massachusetts source portion is generally determined by multiplying the nonresident employee’s total wages by a fraction, the numerator of which is the number of days spent working in Massachusetts and the denominator of which is total working days.  Before the COVID Sourcing Regulation was promulgated, “days spent working in Massachusetts” did not include days spent telecommuting (thus, days worked from home were excluded from the numerator of the aforementioned fraction, see 830 CMR 62.5A.1(5)(a)).  The COVID Sourcing Regulation has essentially converted those non-Massachusetts “at-home” days into Massachusetts days during the pendency of the state of emergency declared at the onset of the COVID-19 pandemic.  This is a targeted effort by Massachusetts to continue receiving personal income tax revenues from nonresidents.

New Hampshire Takes this Battle to the Supreme Court

The Massachusetts Department of Revenue readopted the emergency regulation in July 2020 and, shortly thereafter, New Hampshire Governor Chris Sununu pledged to “take immediate steps to stop any attempts to impose income taxes” on New Hampshire residents “in a manner that violates the law, the New Hampshire Constitution, or the United States Constitution.”  As part of this pledge, Governor Sununu called on Massachusetts Governor Charlie Baker to rescind the Massachusetts COVID Sourcing Regulation in order to avoid the necessity of “legal remedies.”  When that call went unanswered, New Hampshire filed a Motion for Leave to File Bill of Complaint with the Supreme Court of the United States, challenging the validity of the COVID Sourcing Regulation—primarily on constitutional grounds—and seeking to enjoin its enforcement (the “Bill of Complaint”).  As both a “[c]ase . . . in which a State shall be a Party” and a “controvers[y] between two or more states,” the Supreme Court has original and exclusive jurisdiction over the matter under Article III, section 2 of the U.S. Constitution and section 1251(a) of Article 28 of the United States Code.

The Bill of Complaint requests that the Supreme Court (1) declare that the COVID Sourcing Regulation violates the Commerce Clause and the Due Process Clause of the U.S. Constitution, (2) preliminarily and permanently enjoin Massachusetts from enforcing the COVID Sourcing Regulation, and (3) enter an injunction requiring Massachusetts to refund all funds, including interest, collected from nonresidents pursuant to the COVID Sourcing Regulation.  The following is a summary of the alleged constitutional violations.

Alleged Commerce Clause Violations

Under the four-prong test articulated by the U.S. Supreme Court in Complete Auto Transit v. Brady, 430 U.S. 274 (1977), in order to survive Commerce Clause scrutiny, a State’s tax must be (1) applied to an activity with a substantial nexus with the taxing State, (2) fairly apportioned; (3) non-discriminatory (i.e., it must not discriminate against interstate commerce), and (4) fairly related to the services provided by the State.  In its brief in support of the Bill of Complaint, New Hampshire alleges that the COVID Sourcing Regulation fails “all four prongs.”

New Hampshire alleges that the COVID Sourcing Regulation violates the substantial nexus prong because, when a New Hampshire resident is performing work entirely within New Hampshire, Massachusetts lacks “the requisite minimum connection with either the worker or her activity” to constitutionally impose its personal income tax.  The underlying activity (i.e., the work performed by the employee), New Hampshire argues, is the paramount consideration in the substantial nexus inquiry and the COVID Sourcing Regulation “purports to tax nonresidents on income earned from activity lacking any connection with Massachusetts.”

New Hampshire further alleges that the COVID Sourcing Regulation fails the second (fair apportionment) and third (non-discriminatory) prongs of the Complete Auto test because the COVID Sourcing Regulation imposes a tax on activity that is occurring in New Hampshire (thus creating the possibility of discriminatory double taxation in violation of the Commerce Clause).

Lastly, New Hampshire alleges that the COVID Sourcing Regulation fails the fourth prong of the Complete Auto test, which requires the state tax to be “fairly related to the services provided by the state, because the COVID Sourcing Regulation taxes New Hampshire residents “as though they are travelling to and working in Massachusetts—even if they never set foot in the state,” and thus, the tax burden imposed on New Hampshire residents is out of “proper proportion” to their Massachusetts activities.

Alleged Due Process Clause Violations

New Hampshire also alleges that the COVID Sourcing Regulation “violates the[] fundamental requirements of due process” because it “requires no connection between Massachusetts and the nonresidents on whom it imposes Massachusetts income tax other than the address of the nonresident’s employer.”

The Commonwealth of Massachusetts filed its Brief in Opposition to the Bill of Complaint on 11 December 2020 arguing that the case is not appropriate for the U.S. Supreme Court’s original jurisdiction, New Hampshire lacks standing to bring the Bill of Complaint (primarily because the COVID Sourcing Regulation results in no injury to the state itself), and New Hampshire’s constitutional claims lack merit. 13 states have signed onto two separate amicus briefs in support of New Hampshire’s filing.

The Court could make a decision on the Bill of Complaint as early as this month.

Future Implications

While there seems to have been an uptick in U.S. Supreme Court cases involving state and local tax issues over the past several years (the most notable of which being the Court’s 2018 decision in South Dakota v. Wayfair, Inc., 138 S. Ct. 2080), the Court is still generally reticent to take up such matters. Moreover, the Supreme Court historically takes the position that review of disputes between states is not required.  For example, in early 2020, in Arizona v. California, Case No. 22O150 (24 Feb. 2020), it declined review of Arizona’s suit against California seeking to invalidate California’s application of the USD 800 annual minimum tax against out-of-state companies with limited connections to the state.

Even if New Hampshire’s challenge is not accepted, it has a very specific benefit of increasing media attention casting a spotlight on the way certain states impose their personal income tax on nonresidents.  Indeed, the concepts embodied in the COVID Sourcing Regulation are not new; these sourcing provisions, which are colloquially referred to as “convenience of the employer” rules, have been adopted by a handful of states and operate to tax nonresidents working from home as if they are working in the state if the remote work is for the employee’s own convenience, and not out of the employer’s necessity.  The rules have not been without their share of controversy, even in pre-pandemic times.  For example, in Zelinsky v. Tax App. Trib., 1 N.Y.3d 85 (N.Y. 2003), cert. denied 541 U.S. 1009 (2004), New York’s convenience of the employer rule was challenged (unsuccessfully) before the New York Court of Appeals when it resulted in the double taxation of an individual’s income by Connecticut and New York due to Connecticut’s refusal to credit the individual with all of the nonresident income tax paid to New York as a result of the application of the convenience of the employer rule (incidentally, Professor Zelinksy, the taxpayer at issue in that case, filed an amicus brief in support of New Hampshire’s Bill of Complaint).  

For additional insight into how New York has responded to telecommuting during the COVID-19 pandemic, see “New York State Issues Personal Income Tax Sourcing Guidance for Nonresident Employees Telecommuting Due to COVID-19 Pandemic.”).  Now that employees are working from home in mass numbers (many of whom live in a state outside of their employer’s home jurisdiction), these rules (which have sometimes been applied inconsistently from state to state) have garnered a renewed scrutiny.

As employers continue to grapple with what their office spaces will look like in a post-pandemic world, it appears that work-from-home arrangements may become a permanent fixture of the U.S. workforce (although it is currently unknown what percentage of U.S. businesses will ultimately employ a remote workforce once the pandemic is behind us).  Assuming remote work becomes part of the “new normal,” a resolution to these issues (either through the courts or federal action) may be needed (for a discussion of federal legislation on this topic introduced last year, see “Coronavirus Relief Bill Attempts to Address SALT Matters for Telecommuting Employees.”).

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