I started out legal life in California, clerking for the California Supreme Court and, already being a tax geek, was handed many of the state tax issues. So I have some familiarity with California’s tax law. It is complicated and in many policy aspects problematic, but also, to be clear as a lawyer, it is also highly sophisticated as a body of regulatory law. I have not had time to look back to California law and regulations on withholding, and haven’t updated my knowledge of the topic since I clerked there a long time ago and dealt with a couple of minor issues.
However, my understanding then was that withholding law was premised on it being an enforcement mechanism to ensure that the proper tax would be withheld on an expeditious basis and taking account of difficulties in collecting the tax due after the fact. I did not think that it had a basis in law as a revenue raising device in its own right — it was legally an administrative provision for the correct, fair, and efficient collection of tax due, where the actual tax due was figured on the basis of separate statutes.
So I am confused as to the legal authority of the state of California apparently to impose an increase in the withholding rate, not for reasons having to do with the fair and efficient collection of tax finally to be due, but instead to raise revenues or time revenues for reasons not deriving from the administrative necessities of actually collecting a tax, the amount of which is determined by separate tax statutes and regulations. Or have I not understood correctly, from news articles, what has taken place in a legal, tax-lawyer sense?
Starting Sunday, cash-strapped California will dig deeper into the pocketbooks of wage earners — holding back 10% more than it already does in state income taxes just as the biggest shopping season of the year kicks into gear.
Technically, it’s not a tax increase, even though it may feel like one when your next paycheck arrives. As part of a bundle of budget patches adopted in the summer, the state is taking more money now in withholding, even though workers’ annual tax bills won’t change.
Think of it as a forced, interest-free loan: You’ll be repaid any extra withholding in April. Those who would receive a refund anyway will receive a larger one, and those who owe taxes will owe less.
Okay, forced interest-free loan, got that. What I don’t understand is the legal basis for ordering it. I realize that I should do a little legal research, or anyway tell my research assistants to do it, but I’m swamped while still interested — and think it is broadly interesting, and not just in California. So: I would be interested to know particularly if any experienced California tax lawyers could explain for us the following.
- First, what is the statutory or regulatory basis, if any, on which the state of California has justified the change, and, for that matter, where is the change officially promulgated and on whose authority?
- Second, is there precedent for this, as an administrative but also legal matter in California — has this occurred before and has there ever been litigation, administrative or otherwise?
- Third, is there a basis on which to contest the lawfulness of the increase? And further to that, how does that proceed in California — can one proceed on an injunctive basis, on a class basis, what — or is it foreclosed by law or precedent?
- Fourth, even if the Governor or the Legislature has issued the order, does the administrative agency thereby have the authority under California law to carry it out; that is, is it possible that such an order exceeds the authority of the relevant agency?
- Finally, is anyone pursuing such litigation; or alternatively, is the order obviously lawful?
I’m happy to hear people’s views on the policy and political issue, but I particularly welcome comments going to California law and regulations. Thanks.
Update: TaxLawyer (thanks!) provides helpful comments and a couple of links, below. One link is to a client advice memo (ie, public) from the Littler law firm. It provides a good, succinct analysis of the law and the change, and makes clear that the change is a revision to the standard withholding tax schedules. But it also adds that this is essentially a trap for the uninformed (emphasis added):
As part of California’s annual budget ordeal, rather than enacting new taxes, the legislature enacted (and the Governor signed) various income shifting and tax acceleration provisions. Under ABX4-17, as of November 1, 2009, employers will be using a new state income tax withholding table to increase by 10% the amount of income taxes withheld based on existing claimed exemptions ...
Typically, employees adjust the level of income tax withholding by submitting to their employers an IRS form W-4. California also has its own form, DE-4. Employees can submit different forms reflecting their state and federal personal income tax circumstances. Rarely will the use of either or both forms result in withholding that precisely matches the employee’s own annual income tax liability. Ultimately personal tax liability is a matter for the employee.
In an effort to accelerate revenue flow, beginning November 1, 2009, California is adjusting its income tax withholding tax tables by 10%. For example, if bi-weekly state income tax withholding is currently $500 a pay period on an employee’s regular wages, come November 1, such withholding will automatically adjust to $550 ....
As this flat rate adjustment may have no relationship to actual state income taxes, employers can anticipate employees will be potentially flooding payroll departments with revised W-4 and DE-4 forms to “right size” their withholding arrangement. Since nothing in the law forces employees to increase their withholding, an employee can effectively reduce the effect of this law by increasing claimed exemptions, if the new tables would result in excessive tax withholding.
California is proceeding on the assumption that either employees under withhold income taxes through payroll or that employees will not be smart enough to adjust their withholding, and instead give California an interest-free loan of California employees’ income.
That’s with respect to withholding taxes on employment income. There are separate issues with respect to other kinds of withholding, and the Littler memo notes the following. The statutory authorization, ABX4-17
also provides for those who file estimated taxes (typically the self-employed) to also accelerate such payments. Both of these acceleration features raise potential constitutional issues and/or other statutory issues, as in many instances such accelerated revenue receipts exceed an individual’s tax obligations and conflict with other state and/or federal laws obliging an employee to accurately provide for income tax withholding.
David Schwartz says:
I think your argument would make perfect sense if they previously had to pay you interest on the money withheld. But since it’s always been a mechanism to provide the state an interest-free loan (or equivalently, make the taxes due earlier) I don’t see how this is any kind of fundamental change. Before, some people had too much withheld and some too little, the excess was an interest-free loan and the underpayments resulted in the same tax collection issues withholding was supposed to help.
Obviously, the state budget is improved the higher the withholding level. The state gets more interest-free money, and has fewer dollars to collect that aren’t withheld. The rate always converts collection problems into interest-free loans.
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November 7, 2009, 3:59 pmKenneth Anderson says:
David: I agree entirely with the economic logic — it is an interest free loan, and the question is what rate and the implied loan. However, as I more or less recall, the statute in question did not frame it as a matter of a forced loan, even in other kinds of phrasing. I think — and might be mistaken — that it was as justified as a matter of the efficient collection of tax, and of course being sure that it wasn’t spent and not available after the fact. I would have thought that in California law, that purpose would matter in the judicial interpretation of the ability of the state to use the administrative process to hike the tax burden or otherwise allocate payments for reasons unrelated to the efficient collection of a tax, the amount of which is determined under separate statutes. I don’t doubt the logic of your comment for a moment, but wonder whether as a matter of legal interpretation, the legal authority is actually in place or is at least legally contestable.
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November 7, 2009, 4:08 pmAnonymous says:
Third, is there a basis on which to contest the lawfulness of the increase?
That’s a fine question, and I’m just speculating, but I would guess that a provision requiring “efficiency” justifications has no limiting power on a legislature’s desire to shuffle tax timing around. It certainly isn’t limiting government in any other way, eg expressing market forces on failed, bankrupt municipal works projects which they consider a “public good”.
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November 7, 2009, 4:19 pmS.W. Hagwood says:
This move assures that many Californians who owe back child support, accounts with the Franchise Tax Board
(CA’s IRS) & other tax granishment programs will not see any of this money again. Since Bill Clinton’s welfare reforms empowers states to collect directly from employers, it represents a sizable amount. $20 Million wouldn’t be surprising. After all these are people living violation of ‘something’. All good legal Californians will be made whole.
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November 7, 2009, 4:31 pmHenry says:
S.W.–as a matter of fact, not a single “good legal Californian” will be made whole, given that we won’t be compensated for the interest lost in the ensuing period.
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November 7, 2009, 4:49 pmPersonFromPorlock says:
Well, if the legislature makes it clear that any budget shortfalls will hit the judiciary first, I’m sure some legal basis for the witholding increase can be worked out.
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November 7, 2009, 5:00 pmTax Lawyer says:
The bill enacting the change, ABX4-17, is here. Basically, the state is issuing revised wage withholding tables.
The increased withholding is essentially optional: if you are savvy, you will increase your exemptions on your withholding allowance certificate, so that you will continue to get the correct amount withheld. So this is an increase only for the ill-informed, and because everyone could opt out, I’m not sure who would have standing to sue.
There is more good information here.
More generally: Tax is due throughout the year, not on April 15 (or whenever the relevant due date is). If you’re not on a payroll and so don’t get taxes withheld, you have to pay estimated tax. Corporations also have to pay estimated tax.
That said, you should NEVER get a tax refund. That means you have set up your withholding incorrectly and given the government an interest free loan. In the tax department where I used to work, I was merciless mocked by my colleagues for getting a several-thousand dollar tax refund one year for exactly that reason.
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November 7, 2009, 5:02 pmsitzpinkler says:
Complete nonsense.
Life is often unpredictable. If a good housing deal pops up, is a person supposed to avoid the $8,000 tax credit to ensure they don’t get a refund? If the person takes the credit, does that mean the person set up his withholding incorrectly?
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November 7, 2009, 5:08 pmgeokstr says:
I lived in SoCal for 25 years, finally moving to somewhere near totally bereft of Californians (thank the FSM) in 2003. In all that time, all my income was from W-2 earnings, and the withholding rates were such that I rarely got a refund or owed anything. If they are raising the rates now, I have a feeling that a lot of people will be getting IOUs in lieu of a refund check next year, unless of course, the second monstrosity (read: stimulus) will be filled with enough vote-candy to float CA for another year.
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November 7, 2009, 5:20 pmKenneth Anderson says:
TaxLawyer: Thanks, very helpful, your discussion especially as well as the links to the bill and the Littler client advice memo.
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November 7, 2009, 5:24 pmA. says:
All residents of CA should adjust their withholdings accordingly. Certainly nothing prevents them from taking extra exemptions, so long as their final amount withheld is no less than their annual tax burden.
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November 7, 2009, 5:38 pmMikeTheActuary says:
It does, if the person doesn’t adjust their withholding for the remainder of the year, after the opportunity arises.
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November 7, 2009, 5:42 pmHoward Bowman, MD says:
I was born in California, and I was raised in California, and I went to school in California (including Medical school) and I thank G-D every day that I got the hell out of California before this insanity. It became obvious that Arnold was a pumped version of
BeigeGray Davis and wasn’t going to get a thing accomplished for the good.So, I live in Montana and if anyone asks, I came from Canada...the other CA.
As for the justification for this theft? Quis custodiet ipsos custodes?
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November 7, 2009, 5:48 pmDaniel Shinkle says:
There is some precedent for this sort of thing in Federal taxation. For self-employed and others paying quarterly, in the 2d and 3d quarters, the payment is due before the end of the quarter.
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November 7, 2009, 7:06 pmStruthius says:
FSM? Federated States of Micronesia? Film Score Monthly? Flying Spaghetti Monster? Free Speech Movement?
There probably are few Californians in Micronesia, so I’m betting that’s it.
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November 7, 2009, 7:27 pmNew Pseudonym says:
IIRC Federal law or IRS regulations prohibit claiming exemptions that one is not entitled to on Form W-4 if the false exemption results in underpaid taxes. Does CA law have a similar provision that could result in additional liability for those who claimed additional exemptions to avoid the 10% hike but overdo it so that there is tax due at the end of the year?
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November 7, 2009, 7:59 pmMonte Meals says:
Are there any guarantees that an April 15 tax refund will be paid in US dollars as opposed to California IOUs?
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November 7, 2009, 8:19 pmBrian G. says:
It appears to me that people are advocating lawbreaking here by saying people should be changing their W-2s. California has every right to collect the revenue it desparately needs to continue to help women, children, and minorities who depend on the state to proivde them with a social safety net. I think it would be against the priniciples of social justice for people to decide not to assist California in its time of need. We are in a recesion people, thanks to Bush’s bankrupting of the country in order to make his pals at Haliburton, Big Oil, and Wall Street rich. As the biggest state in the country, naturally the devestation left behind by the Bush Regime hits them the hardest. People should show compassion for their fellows peoples and do their part to assist get past this crisis.
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November 7, 2009, 8:43 pmGrigor says:
Thx, Brian G. There’s a special sliver of the extra withholding set aside for the feeding of trolls, please report to Window 3-F to claim your bit.
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November 7, 2009, 8:54 pmBlargh says:
Hi, your friendly neighborhood lefty here. Even if everything past your first sentence is true, the first doesn’t follow. Even in a social democratic state you’re not under any obligation to give the government more than they can take from you.
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November 7, 2009, 9:30 pmGordon Langston says:
Just what law are you breaking when you are just paying the taxes you owe? If your tax payments are insufficient to pay the taxes owed (with a 10% leeway relative to last year’s taxes) then you may pay a penalty for underpayment. Not much to comment on past this except to ask if you live in CA and possibly if you’re tongue in cheek here.
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November 7, 2009, 9:53 pmegd says:
I’m pretty sure that Brian G is engaging in a bit of sarcasm.
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November 7, 2009, 10:13 pmBleepless says:
Legal basis? Ho-ho. How about unrestrained power?
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November 7, 2009, 10:15 pmreadery says:
I don’t see the constitutional problem. California could have enacted a 10% tax increase outright (payable through withholding), and it could have given a 10% rebate outright (payable after filing), so why not in effect do both at the same time?
If this law truly conflicts with other provisions, one attempts to harmonize, and if one can’t the last thing the legislature enacted controls. Earlier statutes can’t be obstacles to later ones; the business of a legislature is to change the law.
A legislature has power to do this. One can grouse, but there really doesn’t seem to be any real beef. Since it’s backed by a statute, any remedy is at the voting booth. Frankly, given the dire straits most state budgets are in and California’s in particular, the hit could have been a lot worse.
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November 7, 2009, 11:00 pmgreat unknown says:
readery:
A tax increase in California requires a 2/3 supermajority by constitutional amendment. The remedy via the voting booth was indeed invoked.
Unfortunately, like most legislative bodies, the California government is seeking to circumvent the results of the voting booth instead of taking proper corrective measures (cut pork, roll back absurd pensions...)that are within their powers, but might cause the politicians to lose said powers.
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November 8, 2009, 12:02 amgab says:
Short term interest rates right now are so low that a few dollars invested at current rates are essentially meaningless. And Dr Bowman, were any of the schools you went to in California public schools?
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November 8, 2009, 12:12 amgreat unknown says:
re gab:
The argument about short-term interest rates is missing the point. If people have to borrow because of reduced cash flow, the interest rates are much higher. Of course, if they reduce spending consequent to the aforementioned reduced cash flow, tax collections will suffer and the entire exercise collapses under the inexorable weight of the laws of economics.
The implied criticism of Dr Bowman is predicated on his coming in from out of state, using the facilities of the public schools as a freeloader, and then escaping without paying back. The more likely scenario is that he and/or his parents shouldered a disproportionate amount of his educational bill in many years of taxes and fees.
It is worth noting that until recently, California, through its citizens, paid its own way.
Recall Dame Thatcher’s aphorism to the effect that one can be liberal until one runs out of other peoples’ money. By its taxation policies, driven by a buy votes — particularly of the unions — with benefits policy, CA has succeeded in driving industry and higher-level taxpayers out of the state. Once again, classic economics trumps Marx and his ilk.
For a ground-up look at this process in action, pay particular attention to Washington State. Boeing just declared that its new 737 production line will be in South Carolina. This is a blow to the Washington economy that could have been foreseen by anybody with an honest appreciation of economic reality. It remains to be seen if the Washington legislators learn from this mistake, or enter into a tighter graveyard spiral of compensating by raising taxes on remaining industry
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November 8, 2009, 1:19 amOren says:
But the individuals can borrow much more cheaply than the State, whose bonds hover in the 8–10% “junk” category. Those people have a very solid future earning potential against which to borrow whereas the State legislature can neither raise taxes nor cut the vast swaths of spending mandated by referendum.
It depresses me to acknowledge, but the experiences here are a lesson in the folly of public choice — when given the power to broadly set policy, Californians made policy that spends more than they are willing to pay. I still have no doubt that The People deserve to make a choice, but someone has to map that choice onto a realizable policy.
Of course, the nature of that mapping is highly unclear to me.
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November 8, 2009, 1:36 amBeth says:
The underlying problem is the precarious nature of California’s finances. Last year the state announced in mid-January that they were not going to process tax refunds because they didn’t have the cash. They eventually started processing them and paid tax refunds with IOUs. Many banks in the state accepted the IOUs and paid their customers cash. But they stopped accepting them in July because this was a bad deal for the banks and they had no confidence that the state would be able to pay. The state stopped issuing IOUs in September after the legislature had brokered a deal that shored up the California cash situation. But most of the gains were accounting tricks–like the withholding changes–with no real improvement in the underlying fundamentals. Many of the supposed reduction in expenses from closing parks to releasing prisoners have been subsequently abrogated. So next year’s finances will be worse.
Last tax year, California was not able to pay refunds for over 8 months after they were due. Unless they’ve got a rabbit in the hat, this tax year will be worse. The real wildcard is whether the banks will cash the refund IOUs this year.
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November 8, 2009, 4:41 amJason Steck says:
If California continues to have end-of-year shortfalls that require payment of tax refunds in the form of IOUs, doesn’t “revenue acceleration” result in a feedback loop whereby eventually the IOUs are themselves not paid (due to a shortage of revenue that eventually exceeds the revenue coming in) and the “revenue acceleration” is, in reality, a de facto tax increase?
Put another way, the “revenue acceleration” seems to give taxpayers a claim against the state for taxes collected in excess of what are owed. But if that claim is not payable because the state lacks the funds (or chooses to prioritize those refund payments lower than other payments that eat up the entire budget), how is that not a tax increase by another name?
And does anyone really think that the California legislature is going to prioritize claims disproportionately held by the hated “rich”?
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November 8, 2009, 9:24 amRichard Aubrey says:
“legal basis”
Are you serious?
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November 8, 2009, 9:27 amGordon Langston says:
Perhaps as a mockery of our legislature someone should attempt to pass an Initiative that allows taxpayers to use IOUs to pay their estimated taxes.
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November 8, 2009, 10:14 amPintler says:
Is this limited to a single fiscal year? By this logic, can CA withhold your 2015 taxes in 2010, for example?
As an aside, I am always struck that financial crisis seems correlated with the size of a government. Small towns seem to handle variations in revenue with much less drama — maybe in a lean year they keep the old backhoe running another year or whatever, and replace it in a good year, all seemingly without much gnashing of teeth (admittedly, I only have knowledge of the few small towns I have lived in).
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November 8, 2009, 10:16 amRichard S says:
It would be fun to put an initiative on the ballot saying that all taxes must be paid in full by April 15, but that no taxes are due before that.
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November 8, 2009, 11:25 amgreat unknown says:
re Oren:
a) This argument echoes the one that says we’ll have to reduce essential services first. Has anyone actually done an analysis of how much money is spent on mandated and generally-accepted-as-necessary programs vs how much is spent on makework, pork, and illegal immigrants ?
b) How much money in necessary and mandated programs is spent on union– and politician-driven featherbedding? Pensions? Or outright fraud [which might be a redundancy]?
c) How much prison/police/prosecutorial/judicial expenses [including number of personnel needed] go down the rat-hole of the war on drugs? At the very least, how much money would be saved by fully legalizing marijuana and granting retroactive pardons to those already convicted of marijuana-related crimes?
Until I see evidence to the contrary, my personal opinion remains that significant amounts of the California budget go to items like a half-dozen redundant administrators telling a worker playing computer games at his desk to prepare a list of firefighters to lay off to reduce the budget, then give said worker a raise so that he can retire with a pension of 110% of his average salary.
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November 8, 2009, 11:28 amDavidwhitewolf says:
We have a small California business with roughly forty employees. I and one other executive were the only ones to file revised withholding forms with our payroll department in response to this statute. So I suspect that the legislature’s right in assuming most Californians will be too stupid/lazy to revise their number of exemptions.
As an aside, although some employers may not provide the W-4/CA-4 to the IRS, many do. If yours is one of them, the old saw is to claim no more than 9 exemptions — 10 or more was said to be the magic number to trigger an audit. Of course, 9 is a hell of lot better than, say, 2, which is what my wife and I had claimed before.
My California tax refund this year was in the form of an IOU, and I’m expecting the same will happen in 2010. So at least I’ll have increased cash-flow in the meantime to make up for it.
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November 8, 2009, 11:47 amBeth says:
With your federal return, it is possible to designate your refund as an estimated payment on the following year’s taxes in lieu of a check. Does any Calif. tax expert know if the state allows this maneuver?
Folks who are anticipating return IOUs could at least let the state give themselves an IOU while significantly reducing their own withholding and estimated tax payments in 2010.
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November 8, 2009, 12:22 pmJohn Lee says:
Maybe this is a stupid question (I skipped all of the tax classes in law school) but is there a reason that the non-payment of interest on either overly withheld taxes or California IOUs doesn’t violate the takings clause? Or is this just an extension of the 16th A that permits the government to withhold in excess and get this interest-free loan?
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November 8, 2009, 1:14 pmgab says:
We’re talking about a 10% increase in withholding — for 99.9% of the population that amounts to a few dollars a paycheck. Nobody is going to have to borrow money to cover the cashflow shortfall and if that’s a problem, just adjust your withholding. I stand by my orig assertion.
And I’m sure Dr Bowman, who most likely benefitted quite handsomely by freeriding on the Calif taxpayer can speak for himself.
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November 8, 2009, 1:26 pmOren says:
John, the 16A has nothing to do with it. California, as a sovereign, has the power to tax income subject to the usual due process and equal protection limitations that apply to all their other actions.
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November 8, 2009, 3:50 pmbystander says:
Gab, Dr. Bowman’s post stated that he was born and raised in California. I am sure that his parents paid taxes, so I hardly think he was a freerider. Do you expect him to remain in California for the rest of his life to repay the state?
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November 8, 2009, 4:00 pmgreat unknown says:
bystander:
It is an article of faith of the left that most if not all successful people owe their success to the State. And owe, and owe, and owe...
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November 8, 2009, 6:22 pmbystander says:
Haha, I had not considered that. As a not-yet-successful Californian, I wish Dr. Bowman luck and encourage other professional Californians to do the same. My own exit is approaching (after taking advantage of public K-12 and a public university), and I look forward to the day that I can be called a “free-rider” as well.
I adjusted my withholding on the advise of a professor and I hope many other tax payers do the same. It isn’t necessarily the interest-free loan that bothers me, but rather the fact that they have the audacity to ask for more after being wasteful (in my opinion) with what they have already collected.
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November 8, 2009, 6:43 pmgeokstr says:
Flying Spaghetti Monster, since as an atheist I cannot thank god.
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November 8, 2009, 6:57 pmNickM says:
Yes. Those guarantees are written on the back of this past year’s Califonia IOUs.
Nick
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November 8, 2009, 7:29 pmJames in MA says:
Arizona did the same thing, but with an added twist. In AZ state tax withholdings are a percentage of federal tax withholdings and you cannot control the number of state exemptions separately. So you cannot cut back on the state’s take without screwing up your federal tax bill.
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November 9, 2009, 10:18 amMark says:
Hello knowledgeable folks —
Do I risk any penalty for increasing my exemptions? Currently i have 2 exemptions on my W-4 and would like to add a third for CA state taxes.
I would rather slightly underpay my taxes and send the state a check in April.
thanks,
Mark
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November 9, 2009, 7:18 pmBeth says:
For those in AZ you could increase your Federal and state withholding exceptions and file a quarterly estimated tax to bring your Federal withholding + estimated to the correct level. You can avoid federal penalties on under-withholding if you make sure that each quarter your withholding plus estimated is at least 25% of your last year’s taxes.
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November 9, 2009, 9:07 pmmark says:
And in CA do i face a penalty if i simply change state withholding from 2 exemptions to 3?
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November 9, 2009, 9:11 pmSacramento Shakedown: your paycheck just got 10 percent lighter says:
[...] Is this sort of thing legal? Yes. The California legislature and the governor realized raising taxes wasn’t the way to go, so they found a dodge: shifting and acceleration. In other words, they changed the withholding tables, not the tax. [...]
J. Harras says:
If a yearly tax for an income is paid by Sept. of the year, is that person going to pay taxs till the end of that year?
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November 14, 2009, 9:40 pmSo Overwhelmed says:
How long will this last? Indefinitely? Did they put a time limit on this bill?
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November 30, 2009, 9:54 pmLech says:
I imagine that the expenditure savings that Prop 187 would have resulted-in—over the last 15 years—is starting to look pretty good about now.
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December 1, 2009, 3:17 pm