Nonresident state income tax withholding has become a hot topic among states, and companies have become aware of the exposure their mobile workforce can create. This Fast Facts attempts to help employers understand some of the risk and complexities with nonresident withholding and how to address potential challenges when trying to become compliant.
Generally, nonresidents are taxed on wages and other compensation earned for services performed in a particular state. Employers and employees are jointly liable for satisfying the tax obligation of an employee that performs services in a particular state, should such state impose an income tax. It is the employer’s responsibility to withhold on an employee’s behalf and remit those taxes to the proper jurisdictions and agencies in a timely manner, subject to de minimis amounts. De minimis thresholds set by certain states are in-state performance of services that amount to a nontrivial amount of days and/or dollar amount that will not trigger an employer withholding obligation.
Each state’s withholding requirements apply to all employers, regardless of size. Wages and compensation are subject to nonresident withholding dependent on each state’s sourcing requirements.
—State withholding requirements and exceptions—
Each state has its own rules to determine when an employer must begin withholding, which can be generally categorized into the following: (i) upon the initial performance of services in the state, (ii) a dollar threshold or percentage of total income derived from performance of services in the state, and (iii) once a certain day threshold is met for services performed in the state. A handful of states offer withholding exceptions for attendance at job-related trainings, such as training, conferences, seminars, or conventions.
—Frequently Asked Questions—
What is a withholding threshold?
The majority of states do not have a withholding threshold and therefore require withholding at the commencement of services being performed in that state. Some states require certain income thresholds be met in order to require withholding (e.g. Wisconsin $1,500). The last category of threshold imposed by states are day thresholds, requiring a certain number of work days in the state before withholding must occur (e.g. New York more than 14 days, Connecticut more than 15 days).
New Jersey employers that require their employees to travel to New York to perform services may have an obligation to withhold New York income tax. New York requires withholding when an employee performs services in the state for more than 14 days. New York provides that any part of a day spent working in New York counts as a full day. New York does provide exclusions for nonresidents that are in New York for the sole purpose of job-related training, such as in-house training courses, trade association conferences or symposia, or professional development workshops, seminars, or conventions.
New Jersey employers that require their employees to travel to Pennsylvania to perform services may have an obligation to withhold Pennsylvania income tax at the commencement of services in the state. When nonresidents perform services in Pennsylvania, their employers must withhold Pennsylvania income tax from their compensation, unless a reciprocal tax agreement applies.
How can I identify my mobile workforce exposure?
In order to determine potential exposures created by traveling employees, employers should analyze their employees’ travel by using transportation data, hotel data, and time and expense detail. Travel should also be analyzed in conjunction with each state’s withholding requirements, and state reciprocal agreements to quantify the exposure related to its mobile workforce. Reciprocal agreements generally provide that if an employee lives in one state and works in another, rather than withholding in the employee’s work state the withholding is permitted in the employee’s resident state.
New Jersey and Pennsylvania have a reciprocal agreement with each other. Under the State of New Jersey and the Commonwealth of Pennsylvania Reciprocal Personal Income Tax Agreement, a New Jersey employer is not required to withhold New Jersey income tax from compensation paid to a Pennsylvania resident employee who files Form NJ-165, Employee’s Certificate of Nonresidence in New Jersey, with the employer. Similarly, a Pennsylvania employer is not required to withhold Pennsylvania income tax from compensation paid to a New Jersey resident employee who files Form REV-419 EX, Employee’s NonWithholding Application Certificate, with the employer.
In addition to tax, what other exposure does my mobile workforce create?
On audit, states generally will impose interest and penalties on under withholding and hold the employer liable for the tax it failed to withhold from employees’ wages. If employees failed to file personal income tax returns, the employer will also be liable for the tax that was not paid by the individual. Further if employers are not reporting on Form W-2 the applicable state taxable wages for employees that are traveling, employees are unlikely reporting that income to the state in which it was earned, putting at risk both the employer and employee.
Other compensation subject to nonresident withholding?
Generally, states require that if a nonresident employee performs services in a state, wages and other compensation are allocable to the state based on the number of days spent performing services in the state in comparison to the total number of workdays spent working everywhere during the compensable period. For regular wages, such as salary, the compensable period is typically the current calendar year.
Other compensation including bonus payments, equity and deferred compensation are frequently earned in one year and paid in a subsequent year. As such, the compensable period for state and local income tax withholding and reporting purposes may span multiple years. States will look at the years related to when the compensation was earned to determine the proper sourcing of such compensation. In addition, the state sourcing rules can vary by state and by compensation type. For example, bonus paid in a current year is typically for services performed in the prior year, and should be sourced based on prior year’s work days in a particular state and not current year’s work days. Stock options may be sourced to a particular state based on the percentage of services performed in the state between the date of grant and exercise (such as California) or grant to vest date (such as New York).
What are some challenges employers face with nonresident withholding compliance?
Many employers face similar issues when trying to comply with the various state requirements on nonresident withholding. Employers encounter challenges implementing a process for tracking employee multi-state travel, payroll system limitations for administering multi-state withholding, keeping up with the ever evolving state withholding rules, and the potential for an incremental tax cost to employees resulting in multi-state withholding.
What’s the need for compliance?
Some states are establishing robust audit programs in an effort to bring employers into compliance. State departments are transitioning from manual audits to computerized audits, to more effectively determine deficiencies within a company’s payroll system and perform audits in a faster more streamlined approach.
What are some solutions employers can implement to become compliant?
Employers should first quantify their multi-state withholding tax exposure based on a review of employee travel patterns and various state rules relating to non-resident de minimis thresholds, reciprocity, etc. The employer can then determine its overall risk profile by identifying its mobile workforce by functional responsibility, compensation level, and/or travel patterns in conjunction with the company’s physical presence and audit activity in the various states. Finally, employers should develop a nonresident multi-state withholding policy tailored to their business needs and risk tolerance, which includes an employee communication, including FAQs. Employers could additionally develop a tracking mechanism and establish policies for maintenance and monitoring to ensure there are checks and balances and that the policy is being properly administered.
—For More Information—
If you need additional information, please contact:
Tina Schrob (firstname.lastname@example.org) or
Jessica Castro (email@example.com) of PricewaterhouseCoopers LLP.
Updated: August 31, 2017
This information should not be construed as constituting specific tax advice. It is intended to provide general information about this subject and general compliance strategies. For specific tax advice, NJBIA strongly recommends members consult with their attorney or accountant.