The first step has finally been taken to address an area of tax law that has materially impacted both corporate and individual taxpayers alike for some time. But don't get too excited...it's not what you may think it is. Nevertheless, the passage of the Mobile Workforce State Income Tax Simplification Act of 2012 by the U.S. House of Representatives in May is an attempt by Congress to substantially simplify state income tax law by imposing a uniform standard for nonresident taxation and employer withholding.
What's the Problem?
Let's face it: the American workforce is not what it used to be. No longer are workers confined to cubicles or tethered to desks. The American workforce has become increasingly mobile, and as a result, the tax issues associated with a mobile workforce have become increasingly complex. While states can generally create their own income tax laws and policies, Congress must ensure that such tax laws and policies do not impede or place a substantial burden on interstate commerce.
How complicated are the rules governing nonresident taxation and employer withholding? Well, approximately 41 states currently impose a personal income tax on income earned by individuals within a particular state's borders. Generally, an employee will earn out-of-state income from working even one day in another state. For example, sending a salesperson to visit an out-of-state customer or an employee to repair a defective product in another state could result in an employee earning income outside the state in which he or she resides. Furthermore, and in most cases, the employer may also be required to withhold state income tax on behalf of the employee and remit it to the particular state in which the income was earned. Yet many employees and employers either fail to understand what their respective tax obligations are under these scenarios or fail to adhere to the rules governing nonresident taxation and state income tax withholding.
The law governing nonresident income taxation and employer withholding varies significantly among state taxing jurisdictions. Some states, such as California, may require employers to withhold income tax on the first day the employee performs services in the state. Similarly, New Jersey, Pennsylvania and North Carolina each require employers to withhold taxes immediately after an individual begins earning wages in each of these respective states.
While the states noted above require employers to withhold income tax on the first day an employee earns income within the state, others may use a "time-spent" and/or "dollars-earned" test to trigger withholding. For instance, Connecticut provides a "14-day" de minimis withholding rule for nonresident employees. Under the 14-day rule, employers are not required to withhold Connecticut income tax from wages/compensation paid to nonresident employees for services performed in Connecticut for 14 days or less during a calendar year, provided the employees are assigned to a primary work location outside Connecticut.
To further complicate matters, some states hold an employee to one standard for personal income tax purposes and the employer to another standard for withholding tax purposes. For example, New York provides that a nonresident's income tax liability is triggered the moment he or she earns income in the state, but the employer's withholding obligation does not become effective until the 14th day that the employee earns wages in the state. Although employers have the daunting task to withhold, employees are ultimately liable for the filing of their own state income tax returns. In reality, an employee who is required to travel for work to various states could be required to comply with as many as 41 different state income tax laws, depending upon where the employee earns income. These variations among state tax laws not only involve the preparation of several tax returns, but can also lead to double taxation and, in certain cases, state tax warrants for individuals who do not comply with the state income tax laws.
Employees not only need to determine if they have an income tax filing responsibility in a state, but they also need to determine whether they are considered a resident or nonresident taxpayer. The resident state is generally the employee's state of domicile. States generally define "domicile" as the place that an individual intends to be his or her permanent home, in other words, the state to which the individual intends to return whenever the individual may be absent. Furthermore, an individual may be considered a resident of a state if the employee spends more than 183 days in such state during the tax year. Nonresidents are generally defined as all other individuals who are not within the definition of a resident.
With all the different filings thresholds and withholding requirements in multiple states, clearly something needs to be done.
The Proposed Solution
In an effort to establish some uniformity among the various states regarding the taxation of nonresidents, the Mobile Workforce State Income Tax Simplification Act of 2012 was passed by the House in May. The Act essentially limits the authority of states to tax certain income of employees for employment duties performed in other states. In its current form, the Act provides that no part of the wage or other remuneration earned by an employee who performs employment duties in more than one state will be subject to income tax in any state other than:
- The state of the employee's residence; and
- The state in which the employee is present and performing employment duties for more than 30 days during the calendar year in which the wages or other remuneration is earned.
Wages earned in any calendar year would be exempt from state income tax withholding and reporting requirements unless the employee is subject to tax under either of the conditions noted above. In the event that an employee is present and performing employment duties in a state for more than 30 days, income tax withholding and reporting requirements will apply to those wages earned as of the commencement date of the employment duties in the state during the calendar year.
The Act would allow an employer to rely on an employee's annual determination of the time expected to be spent by the employee in the states in which duties will be performed absent fraud by the employee or collusion on the part of the employer and the employee. An employer that maintains records in the regular course of its business operations regarding an employee's location may still rely on an employee's determination. However, if an employer, at its sole discretion, maintains a time and attendance system that tracks the location of where an employee performs duties on a daily basis, data from the time and attendance system will be used in lieu of an employee's determination.
Pursuant to the Act, an employee is considered present and performing duties in a state for a "day" if the employee performs more of his or her duties within the state than in any other state during the day. An employee who performs employment duties in a resident state and in only one nonresident state during one day will be considered to have performed more of the duties in the nonresident state than in the resident state. The portion of a day that an employee is in transit will not be considered in determining the location of an employee's duties.
Finally, the Act provides limitations to certain employees. For example, the term "employee" does not include professional athletes, professional entertainers or certain public figures who are persons of prominence who perform services for wages or other remuneration on a per-events basis.
As it currently stands, the Act is important because it:
- Provides a uniform bright-line test for mobile employees and their employers;
- Should result in a reduced administrative burden for employers who have employees who travel and work in multiple states;
- Reduces the number of state income tax filings for employees who travel to multiple jurisdictions for work;
- May provide an opportunity for greater compliance by both employers and employees through a system of laws that might be easily administered;
- May allow employees and employers to forecast their tax liabilities with more accuracy and reduce potential state tax audits; and
- Could result in lower state tax revenue for some jurisdictions, while providing a boost for others.
Alvarez & Marsal Taxand Says:
Stay tuned folks; this one has yet to be resolved, since the mobile workforce legislation has only recently been introduced in the Senate (S. 3485). If enacted, the Act will take effect on January 1 of the second year that begins after the date the Act is enacted. On its face, the Act sounds great ---- a uniform system of taxation in an area that has plagued employees and employers alike for some time. How could it go wrong? But like everything concerning taxes, there will be winners and losers. The resident states may benefit from an increase in revenue, whereas the "nonresident states" may suffer a noticeable loss of revenue at a time when state economies continue to reel from the effects of a sluggish economy. Let's see if an agreement can be reached on this one!
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Brian Drujak, Senior Director, and Emilio Martinez, Director, contributed to this article.
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