An article in Monday’s newspaper about the Military Spouses Residency Relief Act (MSRRA) struck me, at the time, as a case of missing the forest for the trees.
The act, passed on Veterans Day, will extend residential benefits to spouses of military personnel, allowing them to retain residency in their home state for tax and voting purposes.
While the article focused on personal property taxes (the trees), what immediately jumped out at me was the larger impact on the revenues of the Commonwealth (the forest). If a spouse is allowed to claim residence elsewhere while working in Virginia, the income taxes that would heretofore have been paid to Virginia would go elsewhere.
According to the most recent information I could find (pdf), Virginia ranks 5th in the country in terms of the percentage of residents who are active duty military or in the reserves/guard. That same report shows that Virginia ranks third in terms of enlisted personnel, with approximately 109,000 members. Another source estimates Virginia’s total military personnel at 124,000, with approximately 40,000 of those being reserve and national guard. Maryland, which has approximately 57,000 total military members with approximately 26,000 being in the reserve and national guard, estimates the cost to the state for this change in the law to be $5 million. I was unable to readily locate any statistics on the number of returns filed in Virginia by spouses of active duty military members.
My experience tells me that many active duty (AD) service members claim a home of record in a state that doesn’t have income taxes – Texas for Army members, Florida for Navy members – or, as has been increasingly the case, states that do not tax the military member if they are not in the state during the year, like New York or Ohio. Virginia is one of the states that continues to tax the military pay of AD personnel if the Commonwealth is the home of record.
Until the passage of the MSRRA, spouses were taxed wherever they earned their income. Monday’s article sent me hunting for the law and the interpretation of it. What I found isn’t pretty and leaves me wondering: did anyone in Washington actually think this through before this bill became law?
It appears to me that the intent of this law was to simplify things for AD members by allowing their spouses to claim the same home of record. But that wasn’t the way the law was passed. The best explanation I have found for the law as it stands is that provided by the Reserve Officers Association. The examples there are quite clear and the conclusion sobering for those who thought this law was going to make life easy:
The new law is good news for some military families, but because of the way that the law was drafted most military families will not benefit.
I doubt if many people will follow the examples and instead simply claim that their home of record is in a state other than Virginia. (In fact, I’ve already seen, in my research for this article, people advocating claiming a state of residence to which they are not entitled to and letting the states try to catch them.) Although the Virginia Department of Taxation has released a tax bulletin (pdf) saying that they are collaborating with other states on the implementation of the law, my research tells me otherwise. A number of states have already issued guidance, among them:
- Kansas (pdf) places the burden on the employers to determine if the spouse is a resident of another state.
- Colorado (pdf)
I see so many problems with this new law that I’m in the process of contacting my representatives and asking them to reconsider it. The first is that the law was passed so late in the year and is applicable to this tax year, giving the states little time to get things in place. If other states follow the lead of Kansas and place the burden on the employers to determine the residency, where is the guidance on that for the employers? If the burden is placed on the states themselves, how do they intend to track down and verify that those who have claimed the exemption are entitled to it?
Already Virginia is constantly tracking down people with Virginia addresses who haven’t filed returns here. The numbers just go up dramatically with this new law. Another 50,000 – 60,000 returns to look for?
Which brings me to the second point: will Virginia receive additional federal funds for the impact of the lost revenue as well as the additional resources that will be required to track down and determine if the person claiming exemption is entitled to it? If not, this becomes another unfunded mandate placed on the Commonwealth.
Finally, for those spouses who end up claiming residency in states where there is an income tax, this law places a burden on them to make estimated income tax payments in that state. The federal government may be able to withhold income taxes in every state (and locality) that charges them but small businesses simply cannot. Given that the law, as it stands, is in effect for this year, will the states waive the underpayment of estimated tax penalties?
There is no doubt in my mind that the effective date of this legislation needs to be pushed back.
And I have a fairly simple fix to avoid the extra work for the states: an alteration of the W-2. Put a box on there that, if checked, indicates that the employee has claimed exemption from tax in the state in which they work. And put a field next to the box capable of handling the two-digit state code for the state of residence the employee is claiming. Every state requires copies of the W-2 to be sent to them. With a bit of programming, the states could then determine which employees are claiming the exemption and the state in which they are claiming residency, thereby avoiding the “where’s your tax return” notices that get sent out. (And, of course, require all but the smallest employers to file their W-2s electronically.) Updating the W-2 is something that the software vendors are used to doing. The state withholding form (in Virginia, form VA-4) would need to be updated to capture this information as well.
But that can’t happen overnight – certainly not between now and the time that W-2s are required to be filed.
If the effective date of the legislation is not pushed back, I can see this bill costing Virginia millions of dollars at a time when we can least afford it.
Oh – and the effect on personal property taxes? I’m surprised that anyone with an AD spouse has been paying personal property taxes.