Tag: Withholding

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State Tax Withholding – What You Should Know?

In addition to the federal tax rules, every State in the US is sovereign to adopt and administer its own tax rules. Out of the 50 US states, only 7 are income tax-free states. Florida, Nevada, Alaska, Texas, Wyoming, Washington, South Dakota. California is the highest-rate state with a whopping 13.3% rate, New York has 8.9% (and additional 3.9% for individual living in New York City.

In general, the underlying fundamental of the states tax rules is quite similar – you pay tax on your worldwide income to your state of residency (WE WILL HAVE A POST ON RESIDENCY), and you pay tax on your income that is earned in the source state, irrespective of your residency status in that state.

So for example, if you reside in New Jersey and worked in New York for certain number of days, you are taxed in New York on your income earned there, and you are also taxed in New Jersey on the same income (and all of your other income), because you reside in New Jersey. To avoid paying tax twice on the same income, states adopt a tax credit system in which your residency state allows you as a credit taxes paid at the source state.

Many states have agreements with other states pursuant to which the source state forgoes its taxing rights as a source state, and transfers the taxing right to the residency state. These are called reciprocity agreements. Many states have not entered into such agreements, for example, New Jersey. New York and Connecticut, do not have reciprocity agreements among them, although the geographic proximity. Therefore, taxpayers are often required to comply with more than one state’s tax laws.

To ease on the administrative burden, many states adopted rules to provide for a de-minimis threshold, for light travelers or to immaterial income earned in such state. Imagine your job requires you to travel often and to many states and that you crossed the de-minimis threshold in several of the states you traveled to? Consequently, you may be required to file a tax return and pay tax in more than one states. Now imagine that you didn’t know about your filing requirement. This can be expensive, and unpleasant.

Employee –

Imposition of penalties, interest and addition to tax.

Employees are required to file tax returns in every state in which they earned income (or to which their income is allocated). However, most states exempt you from filing tax returns, if the allocable income to such state is below the state’s minimum taxable income (mostly determined by the state’s personal exemption amount). Failure to file tax returns may result in i

Employer –
Employers are also required to comply with state tax rules that apply to employee compensation. Employees are required to withhold tax from the allocable portion of the employe’s compensation to each state the employee had worked into the extent the employee’s presence in such state resulted in crossing the de-minimis threshold. The consequences of failure to properly withhold and pay taxes to the relevant states may have a significant effect on the employer. There are interest and penalties associated with under withholding, there is a risk of state tax authorities audit, and non-curable double tax. Importantly, a failure to comply with state withholding tax requirements can have a major effect on the company’s ability to raise funds, to enter into a successful M&A, to undergo IPO, and to maximize valuation.

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I’ll Take the Audit Risk Then. Really? Will you?

When you get a letter from state tax authority that it initiates a withholding audit, you say to your self, “ then God I’m using that prestigious payroll company”. The problem is that the tax authorities do not care about the taxes withheld, they are interested in the taxes you have not withheld. They care about your out-of-state employees (non-resident employees) that came over for a few days of work, and they care about out-of-state employers which employees are traveling to the state for work.

hat will you choose? If you choose the former, you may pay more than what you really owe (or less), if you choose the latter, you will have examiners at your business for a long period of time, going through hundreds of documents causing you a tremendous amount of legal fees.

 

 

So, what happens when you get that audit letter. A lot. You need to engage payroll, you need to engage HR, and you need to engage state counsel, your accountant and a lot of attention.

 

 

The state tax auditors will perform their audit by examining employees colanders, cell phone call reports, EZ-Pass, and credit card (expense report). They will check if and to what extent employees visited in that state to calculate the days visited in (or the amount of income allocated to) that state. After concluding the result, a deficiency letter may be issued (well, it may not be issued if you are among the 30% businesses in the US that somewhat comply with the complex withholding tax rules). In the deficiency letter, they will include the amount of tax, interest and penalties are owed to that state. In most cases, the examiners will only audit a few (or a few more than a few) employees and extrapolate the rate of deficiency to the entire amount of compensation paid to your employees. You can now choose, except that extrapolation, or demand the tax authority to conduct an audit on all of your employees. W

 

So, will you take the audit risk?

 

Let me tell you a personal note (as a former tax authority examiner), the worst thing for an examiner is to find out that during an audit that the taxpayer you’re auditing has complied with all the complex withholding rules. Here the examiner reaches a not so good of ROI (of time).

 

So, still thinks it makes sense to take the audit risk?

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When? and Where? – Withholding Tax De Minimis

De Minimis

Traveling for business to a state that is not your primary working state exposes the traveler employee to taxation and to filing requirements in that state, and also exposes the employer to withhold and pay to that state its allocable share of the overall withholding tax deducted from the employee’s income. Basically, states can tax traveler employees’ income from the first Dollar allocated to that state, however, to ease on the administrative burden, many states adopted rules to provide for a de-minimis threshold, for light travelers or to immaterial income earned in such state. Some states also entered into reciprocity agreements on which we will discuss in a separate post.

States adopted different and unrelated de-minimis rules, which, if you have several employees that travel to more than one state, requires the employer to comply with many different rules, guidelines and policies.

 

Here are some examples of the de-minimis rules applicable in 2018:

 

State Criteria Policy
New York First day of travel Only after 14 days of travel
Connecticut First day of travel Only after 15 days
New Jersey First day of travel
Pennsylvania First day of travel First $ earned within state
California $ amount ($1,500)
South Carolina $ amount ($1,000)
Maine 10 days
Ohio 20 days
Georgia 23 days OR $5,000 Or 5% of total income
Utah 60 days

 

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Compliance? Is It Doable?

It is becoming an easy target by states in the recent years, to audit out of state companies’ traveler employees. New York alone increased its tax collections through an audit in the last several years by tens of millions of dollars, and the numbers grow exponentially. A large number

 

 

of the largest companies in the US has formed a coalition (theWorkforce Coalition) to try and pass a federal law to minimize their state tax withholding, and to transfer the non-compliance penalties from the employer to the employee. One of the arguments is that complying with so many different tax rules is extremely expensive and tracking employees whereabouts, in order to comply with states’ withholding requirements is impossible. Today, the only way, so the Coalition, to track employees whereabouts is via expense reports and time sheets submitted by the employees. Today, New York is the leading state to stand against this federal legislation, for obvious reasons, and it does not look like the Coalition will succeed in its efforts. So there is an obvious need to (1) enable employers to accurately track employees whereabouts and (2) to do that in a cost-effective way.

 

So far, it may make some sense (or so I hope) and seems straightforward, but let’s complicate it a bit. Because each state is sovereign to adopt its own rules, some states allow non-resident taxpayers a threshold until reaching of which, no tax is imposed.

 

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Tax Residency

In most of the tax systems in the world, tax is imposed on a taxpayer based on such taxpayer residence (Residency Taxation) and based on the jurisdiction the income was earned (Source Taxation).

Consequently,  if you are a resident of a country, or a state for tax purposes, you will be subject to tax on your worldwide income, whatever source derived, at your country of residence. You may also be taxed at a jurisdiction where you earned income. In situations where a person paid tax at country of source, most often, the country of residency will provide tax credit for the amount paid at the country of source, to eliminate double taxation. Given that the state of residency imposes tax on the person’s worldwide income, it is crucial to understand how residency is determined, especially for individuals traveling for work, to avoid being subject to tax in more than one country, as a resident.

 

International – most of the countries in the world determine residency of an individual based on number of days present ion that country, and some countries also determine residency based on the “center of life” of the individual. Generally, if you are present in a country for 183 days or more (this is to say, 6 months and a half of a day), you are considered a resident of that country. A day for tax purposes is even a few hours, so it is theoretically possible for you to spend more than 183 days in more than one country.

 

Therefore, DAY COUNT COUNTS!

 

USA – in the US, you are a resident of a state if you domicile in that state. In some states (NY for example), you can also be considered a resident if you maintain a home in NY, AND you spent 183 days or more in that state (Statutory Resident). Stoping for coffee on the way to the airport from Connecticut to Newark airport, in a coffee shop (or to fill up gas at a gas station) in NY, counts as a day in NY. The potential double tax effect resulted in from being considered a resident in two states, one state as the state of domiciliary and the other as a statutory resident because of the time spent in that state, can be painful.

 

Therefore, DAY COUNT COUNTS!

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I Can File and Pay Once a Year! Or Can’t I?

Like any other creditor, tax authorities would like to get their dues as soon as possible. New York, for example, requires that every employer must file, within three days after the payroll period, a return and pay the tax withheld from its employees after each payroll period (in most cases, every two weeks) that causes the total of tax required to be withheld in excess of $700. In addition, New York requires an employer to file a quarterly return to report the compensation and the tax withheld. New York allows to remit withholding taxes that have not been remitted during the quarter, without penalties or interest, but only so long as such amount is not in excess of $700. So if you failed to withheld and pay the tax to New York, and the amount is in excess of $700, interest will be charged.

So to your question, YES you can pay the tax only once a year, but that amount will include a 9% interest (annually) computed from each month you failed to pay the tax, till the payment date. That’s an expensive loan, isn’t it?

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