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.