In most states, payroll tax filing requirements generally include income tax withholding on employee earnings, unemployment insurance contributions and disability insurance contributions. Generally, for withholding purposes, residents are subject to withholding on all of their wages, while nonresidents are subject to withholding only on their wages earned within that state.
Thus, employers are left to determine where their employees earn their wages.
Moreover, if an employee receives compensation attributable to more than one year—such as stock options—employers can face significant challenges with determining how to allocate the compensation to each state.
If an employee receives compensation attributable to more than one year—such as stock options—employers can face significant challenges with determining how to allocate the compensation to each state.
Roughly 16 states have entered reciprocal agreements with other states to require withholding only in the resident state. For example, Pennsylvania has entered reciprocal agreements with Indiana, Maryland, New Jersey, Ohio, Virginia and West Virginia. Illinois has entered reciprocal agreements with Iowa, Kentucky, Michigan and Wisconsin. These contractual agreements between states can be particularly beneficial for employers that are located close to a border of a sister state. In addition, a limited number of states have adopted thresholds before an employer is required to withhold on a nonresident employee's wages. These thresholds can be based on days worked within the state, wages earned within the state or some combination of days worked and wages earned. For example, for New York withholding purposes, an employer is not required to withhold tax if it reasonably expects that the nonresident employee will work 14 days or less within New York during the year (although the employee may still have a nonresident personal income tax filing obligation).1 Georgia is an example of a different type of threshold whereby the employer is not required to withhold if the nonresident employee works in the State for 23 days or less during the calendar quarter and the compensation paid to the employee does not exceed the lesser of $5,000 or 5% of the nonresident's compensation.2
Nevertheless, many states, such as California, do not have any minimum threshold (apart from the low income filing threshold) and can require withholding based on a single day worked within the state. 3 With the prevalence of the mobile workforce, complying with these rules can seem like a herculean task. However, there is proposed federal legislation that would limit that burden and ways to mitigate the risks involved.
PROPOSED FEDERAL LEGISLATION
Currently proposed federal legislation could change the state withholding landscape. The Mobile Workforce State Income Tax Simplification Act of 20194 is a pending federal bill that would limit the states' power to tax nonresidents and simplify withholding tax compliance for employers by establishing a 30-day threshold below which a state could not impose personal income tax on nonresidents. Thus, an employer would not have to withhold unless an employee's visits to a particular state exceeded 30 days.
Notably, the legislation does not apply to professional athletes, professional entertainers and certain public figures. In addition, the legislation does not provide protection against the imposition of corporate income taxes or sales and use taxes based on the presence of nonresident employees working within the state. Similar versions of the bill have been introduced in previous years but have not passed despite growing bipartisan support. 5 The bill is currently with the Senate Committee on Finance.
Not wanting to wait for federal legislation, Illinois recently enacted legislation based upon these same thresholds. 6 With any luck—and the work of many organizations, including the Council on State Taxation—other states will see the logic in not overburdening their corporate citizens and pass similar legislation.
BEST PRACTICES FOR MANAGING EXPOSURE
For many employers, it is difficult to maintain 100% compliance with state and local withholding requirements due to the variations in state thresholds and practical problems with tracking the travel for all employees and reporting it to their payroll departments. In order to reduce their exposure, employers should consider establishing policies for employees to report their travel.
State tax departments are well aware that it is difficult for employers to comply with the requirements discussed above. As such, they often audit employers to seek to identify liabilities for underwithheld taxes, plus impose penalties and interest. A cynic would say that auditing an employer is more efficient in bringing in tax dollars than identifying and conducting personal income tax audits for individual employees—and the cynic would be right. Oftentimes if the employer has not withheld on an employee's income in nonresident states, the employee has not filed personal income tax returns in those states where the employee worked.
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1 N.Y.S. Dep't of Taxation & Fin., TSB-M-12(5)I, Withholding on Wages Paid to Certain Nonresidents Who Work 14 Days or Fewer in New York State (July 5, 2012).
2 Ga. Code Ann. §§ 48-7-1(11), 48-7-100(10)(K).
3 See Cal. Emp't Dev. Dep't, DE 231D Rev. 12, Multistate Employment (Dec. 2017).
4 S. 604, 116th Cong.
5 The House of Representatives passed comparable bills in 2012 (H.R. 1864, 112th Cong.) and 2016 (H.R. 2315, 114th Cong.) but both bills stalled in the Senate.
6 S. 1515, 101st Gen. Assemb. (Ill. 2019).
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Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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