Presentation on theme: "Chicago Chapter Tax Executives Institute February 25, 2014"— Presentation transcript:
1Chicago Chapter Tax Executives Institute February 25, 2014 Current Developments in Compensation and BenefitsMary (“Handy”) Hevener(202)Andy R. Anderson(312)Morgan, Lewis & Bockius LLP
2Final Affordable Care Act Shared Responsibility Rules Andy R. Anderson(312)Morgan, Lewis & Bockius LLP
3Final Shared Responsibility Rules ReleasedPrior day ( ) was a key date in numerous transition rulesFinalizes proposed rules from late 2012Key concepts:Very similar in scope and content to proposed rulesRetains and expands proposed transition rulesRetains and expands full-time employee determinationsRetains and clarifies affordability safe harbors
4Final Shared Responsibility Rules Confirms 2015 Shared Responsibility effective date for large (100 or more FTE/FTeq) employersExpands proposed 95/5% “offer” rule to 70/30% for 2015, but can still lead to “inadequate coverage” penaltyThe 70% expansion creates new planning opportunitiesDelays Shared Responsibility effective date until 2016 for mid-size employers (50 to 99 FTE/FTeq)Numerous requirements and a necessary certification in order to qualifyPlaces new emphasis on when an employer is “small” enough to escape Shared Responsibility rules for 2015
5Final Shared Responsibility Rules Lots (and lots, and lots) of small detail changes that are grounded in comments to the proposed rules and special interest lobbyingFinal Regulations are generally “clean” for 2016 and beyondSpecial rules, transition relief, etc. are found in the preamble to the final rules, the preamble to the proposed rules, and releases that predate the proposed rulesMust, as a result, check multiple sources, particularly for 2015 specifics
6Final Shared Responsibility Rules Preamble nice overview of law, prior guidance, and proposed rulesSee also new Q&As on IRS website:Imbedded expectation for more “subregulatory” guidance in a number of areasSuch as additional FAQs, Q&As, etc.Next up: Reporting Rules
7Prior/Future Material ACA considerations for employersACA considerations for group health plansACA considerations for individualsCompanion LawFlash to Final Rules is in the pipeline
8Who Is Subject to the Shared Responsibility Rules in 2015? Only employers with 100 or more FT/FTeq employeesOn average, at least 100 FT/FTeq employees on business days during the previous calendar year (initially 2014)Six-consecutive-month transition rule for 2014Determine if “large” by adding together:FT employees30 hours per week (or 130 hours per month)FT employee equivalentsTotal hours worked by all PT employees divided by 120From all controlled group employersReserved for government and church employers
9Who Is Subject to the Shared Responsibility Rules in 2015? Special rules for:Seasonal employees (reasonable good faith definition)New employers (look at reasonable expectation for current year)Counts all employees—even those eligible for Medicare, Medicaid, or other employer coverageExempts most overseas employeesPredecessor employers (still reserved for future guidance)Most employers will know, well in advance of 2015, whether they are subject to the employer mandate
10Who Is Subject to the Shared Responsibility Rules in 2016? Expanded to include employers with FT employeesApplied the same as 2015 rules for larger employersMeasured on the basis of 2014 workforceMust maintain size and hours of workforce for period from toMust maintain previously offered coverage (if any) fromMust certify compliance as part of section 6056 reportingWhich apparently will apply to such employers for 2015Does not generally carryover other 2015 transition rules
11Non-Calendar Year Plans There are revised and new (but still limited) delayed effective date rules for non-calendar year plans existing (and not modified) afterDelayed until start of non-calendar year for any employee eligible to participateDelayed until start of non-calendar year for all employees (whether previously eligible or not) if:Offered plan to at least 1/3 of all employees at most recent OE before ; orCovered at least 1/4 of all employees on a day in 12-month period ending
12Non-Calendar Year Plans Delayed until start of non-calendar year for FT employees (whether previously eligible or not) if:Offered plan to at least 1/2 of ACA FT employees at most recent OE before ; orCovered at least 1/3 of ACA FT employees on a day in 12-month period endingUseful for employers with a significant percentage of employees who will not become ACA FT employeesAlso applies to 2016 delay for smaller employersRegardless, must do Section 6056 reporting for all of 2015
13Shared Responsibility Basics No Coverage PenaltyInadequate Coverage PenaltyIf employer does not offer Minimum Essential Coverage to 95% of its FT employeesIf employer offers coverage to its FT employees, but the coverage is not Affordable and/or does not provide Minimum ValueANDOne FT employee enrolls in an Exchange and receives a subsidyEmployer must pay penalty of:$2,000 (indexed) for all FT employees (less 30) (including those receiving coverage)$3,000 (indexed) for each FT employee receiving a subsidy (capped at the maximum No Coverage Penalty)
14No Coverage Penalty Offer At least 95% of all FT employees (and their children in 2016) or at least 70% for 2015FT employee = 30+ hours per week (130+ hours per month)Treasury refused to increase above 30 hoursChildren now excludes foster children and stepchildrenMust offer coverage through end of month in which child attains age 26Excludes children who are not citizens or residents of the U.S.But includes children resident in Canada or MexicoQualifying coverage . . .“Minimum Essential Coverage” (basically any ER-sponsored plan)
15No Coverage Penalty Or pay No Coverage penalty $2,000 times all FT employees (minus 30; 80 for 2015 only)Note: employers who have less than 30 FT employees (or 80 for 2015) will pay no penaltyOnly applies if one FT employee enrolls in Exchange and receives a subsidy (tax credit or cost-sharing reduction, called a “Section 1411 Certification”)No subsidy available if:Eligible for Medicaid ( % of federal poverty level)Household income is more than 400% of federal poverty level
16No Coverage Penalty Offer includes offer of coverage from: Calculated on ALL FT employees of each controlled group member separately30/80 employee reduction apportioned across controlled group membersOffer includes offer of coverage from:Multiemployer/single-employer Taft-Harley plansAdditional interim guidance for near futurePEOs (if client pays more for the offered coverage)MEWAs
17No Coverage Penalty Includes Evergreen offers Offer by one controlled group member satisfies obligation for all membersUseful for large single plan across the entire controlled groupNo specific rules for demonstrating an offer was madeLimited “no offer” opportunity for coverage providing minimum value that is free or meets Federal poverty level affordability safe harbor
18Inadequate Coverage Penalty OfferTo all FT employees (and their children in 2016)—or fail to offer to up to 5% (up to 30% in 2015) of FT employeesFT employee = 30+ hours per week (130+ hours per month)Children now excludes foster children and stepchildrenMust offer coverage through end of month in which child attains age 26Excludes children who are not citizens or residents of the U.S.But includes children resident in Canada or Mexico
19Inadequate Coverage Penalty OfferQualifying coverageIs “Minimum Essential Coverage” andProvides “Minimum Value”That is AffordableNot more than 9.5% of household income for employee-only coverageSafe harbors (discussed later)
20Inadequate Coverage Penalty Or pay Inadequate Coverage penalty$3,000 per FT employee who receives subsidy (Section 1411 Certification) for Exchange coverage (capped at maximum No Coverage penalty)No subsidy available if:Eligible for Medicaid ( % of federal poverty level)Household income is more than 400% of federal poverty levelApplied separately to each controlled group memberLimits scope of penalty to only part of controlled group
21Who Is a Full-Time Employee? Average 30 hours of service/weekFor non-hourly employees, 8 hours/day or 40 hours/week equivalencies130 hours/month can be usedDifferent from large employer determinationNo need to combine PT employees into full-time equivalentsDetermined on a controlled group basisVery challenging for transfers within a controlled group
22Who Is a Full-Time Employee? Determination of FT statusUnder statute, this is determined monthly on an ongoing basisFinal rules contain new details and procedures for determining status on a monthly basisPlugs some of the prior holes applicable to monthly determinationsVery complicated new final rules for when individuals move between different methods of determining status over their careersSpecial phased retirement (and similar situations) ruleEmployees whose status is clearly full time when hired must be offered coverage within 3 months of hire
23Who Is a Full-Time Employee? Voluntary safe harbor method for new variable hour, seasonal, and part-time employeesPermits employers to calculate employee hours during an initial measurement period (3-12 months after employment) and lock in the resulting status for the following stability period (6-12 months)Employer can define periods, subject to consistency, based on categories of employees (i.e., salaried/hourly, union/non-union, different entities, different states)Short (less than 2 months) administration period to start coverage if use full initial measurement periodWill be complicated to track and implementNote new part-time requirements!!
24Who Is a Full-Time Employee? Voluntary safe harbor method for ongoing employeesPermits employers to calculate employee hours during a consistent ongoing measurement period (3-12 months) and lock in the resulting status for the following stability period (6-12 months)Employer can define periods, subject to consistency, based on categories of employees (i.e., salaried/hourly, union/non-union, different entities, different states)Expected to be tied to open enrollment process and timing90-day administration period to start coverageMust transition new variable hour, seasonal, and part-time employees to this ongoing measurement process
25Who Is a Full-Time Employee? Special rules for:Seasonal employees (6 month rule)VolunteersSchoolsAdjunct faculty (new 2-1/2 hour equivalency)Rehired employees (now 13 consecutive weeks—still 26 for educational organizations)International employees and transfersTemporary staffing firmsSection 3508 employeesCruise ships
26Who Is a Full-Time Employee? U.S. territoriesStudent work-studyOn call hoursLayover hoursReligious ordersHome healthcare workers
27When Is Coverage Affordable? Necessary to avoid Inadequate Coverage penaltyPremium for cheapest employee-only coverage must be less than 9.5% of household incomeNo cap on spouse/children premiumsMay be up to COBRA cost of coverageThree optional safe harbors remain and are clarified:W-2: Premium cannot exceed 9.5% of the employee’s W-2 wages from the employer for that yearNew special rules for partial years
28When Is Coverage Affordable? Rate of Pay – Premium cannot exceed 9.5% of an amount equal to 130 hours multiplied by the lower of the hourly rate of pay on the first day of coverage or the lowest hourly rate of pay during each month (if reduced)Alternate is monthly salary on the first day of the coverage period—which cannot be reducedFederal Poverty Line – Premium cannot exceed 9.5% of an amount equal to the Federal poverty line for the year divided by 12Can use the most recently published guidelines in effect 6 months prior to the beginning of the plan year
29Lingering Concerns Nondiscrimination rules ERISA section 510 claims Particularly worrisome if employer has different health coverage across its controlled groupERISA section 510 claimsACA Whistleblower claimsCadillac TaxSome coverage may be too rich for 2018Is 2015/2016 the time to cut back?
30New Developments in Payroll Tax Controversies: Traveling Employees Crossing U.S. and State Borders, and Developments in Independent Contractor AuditsMary (“Handy”) Hevener(202)Morgan, Lewis & Bockius LLP
31Overview Federal Data Collection Program Audits Payroll Audits of Expatriate and Impatriate EmployeesWage Recharacterization AuditsState Payroll Tax Audits of Traveling EmployeesDevelopments in Independent Contractor Audits
33Data Collection and Fringe Benefit Audits, Overview Since 2009, the IRS has audited over 2,000 employers (under a program that the IRS initially hoped would cover examinations of 6,000 taxpayers during ).Most of these audits were of small companies, with an intention to extrapolate the audit results, to measure “business’s compliance” with worker classification, fringe benefit, and payroll tax laws.The IRS’s first extrapolation report was deemed, in May, 2011, by the Treasury Inspector General for Tax Administration to be “too small of a sample to provide meaningful compliance estimates,” so the IRS was required to restart big company audits in 2012 (most in Silicon Valley).
34Data Collection and Fringe Benefit Audits Initial IDRs in these audits cover hundreds of issues, and can take over a year to complete.There are typically five basic areas identified for attention during these audits.(Call Mary Hevener for samples of initial IDRs.)
35New IRS IDR Procedures with Mandatory Enforcement Provisions To comply with the New IDR response deadlines, and to avoid the prompt delinquency notices and summons enforcement procedures outlined in LB&I Directive ), taxpayers need to be ready to explain to the Exam team how long the information will take to be collected and why it will take that long. This includes determining:Do you have the information the IRS seeks?Where is the information and what format is it in?Who will be responsible for obtaining and organizing the information and how long will it take that person to do so?Who needs to review the information before it is delivered to the IRS and how long will that take?Are there any privilege or confidentiality concerns? That may require additional review.
36New IRS IDR Procedures with Mandatory Enforcement Provisions Need to ensure that everyone involved in the examination within your organization is aware of the IDR’s deadline, because once you agree to the deadline there is virtually no way to extend it and the new enforcement provisions are mandatory.If you miss the initial deadline in the IDR, the IRS will issue a “Delinquency Notice” within 10 days of the missed deadline and may allow up to 15 days to provide a response.
37Data Collection and Fringe Benefit Audits Fringe benefits;Likely to include use of company cars, planes and home computers, spousal travel, corporate apartments, prizes and awards, tax return preparation, meals (including on-premises cafeterias), life insurance, and various de minimis items (including gift cards)Reimbursed expenses;Code § 62(c) complianceExecutive compensation;Including deferred compensation and stock-based awards, such as qualified and nonqualified stock options, restricted stock, various phantom stock programs, and for larger companies, Code §§ 162(m) and 280G issues.
38Data Collection and Fringe Benefit Audits Payroll tax compliance (including expatriates, and NRAs traveling to the U.S.); andFocused on W-4/W-9 collections (including investigations of employees who have claimed “exempt status” or too many exemptions), information return compliance (including inquiries about individuals who have received both Forms W-2 and 1099-MISC), B-1, J, and H-1B visa issues, and payroll tax deposit timing (with focus on options/RSUs).Worker/independent contractor classificationFocused on, ultimately, collecting solid revenue estimates for an expected Administration proposal to repeal § 530 of the 1978 Revenue Act (as sponsored by then Senator Obama).
39Data Collection and Fringe Benefit Audits Possible State ReferralsNot only are these IRS audits painful processes, but, given increased coordination between the IRS and state tax agencies, it is possible that audit findings will be coordinated with state tax authorities.Many states have longer statutes of limitations – some extending two or three years after the employer pays taxes to the IRS at the conclusion of the IRS audit, which leads to painful delays, and problems with data-retention.If the employer does not “confess” to the state its payment of taxes to the IRS, the state SOL may never run (e.g., in California).
40Procedural Delays in Getting to IRS Appeals So many IRS Appeals Officers have retired over the past 3 years that there is a huge backlog in IRS processing of protests, particularly those on payroll tax issues.Many of the Protests filed with respect to the “data collection audits” of larger employers, which started in late 2011, have not yet been considered even at a first meeting at Appeals.Although the IRS insists that taxpayers have only 30 days (or even less) to file a Protest, the delay before the first Appeals Meeting is 12 to 15 months.
412010 Increase in Information Reporting Penalties The Code includes not only penalties on individual taxpayers for underreporting income and underpaying (or late-paying) taxes, but also imposes penalties on employers for making the same types of errors.These penalties were dramatically increased in late 2010, effective for information returns filed in January 2011 for 2010 (although there is a typo in the I.R.M., indicating that for “small employers,” the increased penalties may be delayed until the 2011 year).Also, employer’s liability for underwithholding on executives increased in 2013 when the withholding rate on supplemental wages over $1,000,000 jumped from 35% to 39.6%.
422010 Increase in Information Reporting Penalties The post-2010 penalties imposed under each of Code § § 6721 and 6722 are:$100 per W-2, up to maximum of $1,500,000 for all such failures in the aggregate for the year;$30 per W-2, with $250,000 annual cap if corrected within 30 days of January 31;$60 per W-2 with $500,000 annual cap if corrected on or before Aug. 1;In cases of intentional disregard, greater of 10% of underreported amount or $250 per W-2 (with no annual cap).Note that lower annual caps apply to small employers with gross receipts under $5,000,000.
432010 Increase in Information Reporting Penalties For errors on any single W-2 (or 1099), this change has effectively doubled penalties – from $100 to $200 per return – since penalties are imposed on errors in both the employee and employer copies of the forms.For errors by large employers (which affect 15,000 or more employees), the penalties have increased six-fold, from $500,000 to $3 million.Lower caps apply to small employers with gross receipts under $5M.For “intentional disregard” errors, the penalty is 20% of the underreported income.
442010 Increase in Information Reporting Penalties Have these changes increased the accuracy of information returns?Perhaps information returns are more accurate, but certainly these higher penalties (and higher withholding rates on executive compensation) have increased the “worry factor” for return filers.Will these changes increase the frequency of audits?Maybe, and they certainly will increase costs for those audited.They have also lead to more “computer-notice” assessments.
45Federal Payroll Audits of Cross-Border EmployEES: COMMON AUDIT ISSUES
47Common Audit Issues for Cross-Border Workers: Tax Return Preparation – IRS Arguments The tax return preparation benefits only the employee.The Code §132(d) exclusion does not apply to § 212 deductions (e.g., return preparation). See Reg. § (a)(1)(iii); Code § 212; Rev. Rul ; P.L.R ; P.L.R ; and F.S.A (all addressing employer-paid tax return preparation).The exclusion for non-discriminatory qualified retirement planning services under § 132(m) is not applicable.The employer’s cost measures the benefit value.
48Common Audit Issues for Cross-Border Workers: Tax Return Preparation – Employer Response The assessed tax preparation costs should be excludable under Code § 132 as a working condition fringe benefit because incurred primarily for the employer’s benefit. See, e.g., Rev. Rul (applying this principle to job- search expenses to terminated employees). Even the ruling cited by the IRS imply that under certain conditions the working condition exclusion could apply.There is ample pre- and post-TRA ‘84 guidance indicating that property and/or services provided to employees for an employer’s benefit should be excluded from wages.See also Rev. Rul (question 31); Doak v. Comm’r, 234 F.2d 704 (1956); and Teeling v. Comm’r, 42 T.C. 671 (1964), acq C.B. 6 (all allowing deductions for personal meal and entertainment expenses, where it is clearly shown that the taxpayer was incurring costs exceeding those that would have been incurred for their personal expenses).
49Common Audit Issues for Cross-Border Workers: Tax Return Preparation – Employer Response Cost cannot be used to measure value, per Reg. § (b)(2).The amount payable by an employee for the U.S. return preparation is the effective value.The IRS should accept values of $350 to $500 as income imputed to employees for this benefit. (Notably, $500 is more than double the value of tax return preparation services, as estimated by the National Society of Accountants and the IRS.)
50Common Audit Issues for Cross-Border Workers: Tax Return Preparation – Employer Response Because expatriates are only responsible for the hypothetical “stay at home” tax, the value received by these employees for domestic and foreign tax return preparation services is far less than the employer’s cost.Much of the return preparation cost is aimed at minimizing the tax equalization payments due expatriates.Expatriates do not benefit from foreign tax return preparation services because they are guaranteed tax equalization payments and gross-ups.Any tax attributes (including FTCs) that generate tax reduction in an expatriate’s return for prior or future periods, including pre- and post-assignment periods, solely benefit the employer.
51Common Audit Issues for Cross-Border Workers: Tax Return Preparation – Employer Response The facts for most employers are clearly distinguishable from those described in Rev. Rul and P.L.RUnder the facts of Rev. Rul , the services were rendered primarily for the benefit of the employees.For most employers, the foreign tax preparation expenses were incurred primarily for the employer’s benefit (as discussed above).P.L.R differs from most employers’ situations, since few, if any, expatriate employees are ever given a choice between the tax preparation services and cash.
52Common Audit Issues for Cross-Border Workers: Expatriate Withholding – IRS Arguments Withholding should have been collected on wages while the employees were traveling.The Code § 911 exclusion was inadequate to protect the wages from withholding.The “exempt status” Forms W-4 were completed incorrectly (per inclusions of requested exemptions), or had expired (on Feb. 15 of every year).The only way for an employer to abate its liability for underwithheld income taxes is to collect originally signed Forms 4669 from each affected employee.
53Common Audit Issues for Cross-Border Workers: Expatriate Withholding – Employer Response Wages paid to U.S. citizens performing services in a foreign country for an employer are exempt from withholding if at the time of payment it is reasonable to believe the employee’s wages will be excluded from gross income under Code § See Treas. Reg § (a)(8)(A)-1(a)(1)(i).In many instances, the IRS agents’ computations of the Code § 911 exclusion significantly understate the available exclusion.
54Common Audit Issues for Cross-Border Workers: Expatriate Withholding – Employer Response Qualified individuals could exclude up to $91,500 in $92,900 in $95,100 in 2012, $97,600 in 2013, and $99,200 in See Code § 911(b)(2)(D)(i); Rev. Procs , , , , andThe Code § 911 exclusion amount is computed on a daily basis based on the number of days that fall within the employee’s qualifying period during the taxable year. See Code § 911(b)(2)(A).Pursuant to Reg. § (d)(2)(i), to determine the maximum exclusion amount, the annual exclusion amount is multiplied by the following fraction:The number of qualifying days in the taxable yearThe number of days in the taxable yearIRS agents often misapply (or ignore) this exemption.
55Common Audit Issues for Cross-Border Workers: Expatriate Withholding – Employer Response In addition to the Code § 911 exclusion, Code § 3401(a)(8)(A)(ii) (and the underlying regulations) provide a wage withholding exemption for remuneration paid for services by a U.S. citizen employee in a foreign country if the employer is required by the law of a foreign country to withhold income tax upon such remuneration.The tax need not be imposed under general income tax laws of the foreign country, so as the foreign tax would otherwise qualify for credit (if elected) under Code § See P.L.RSome IRS agents insist on detailed explanations (and translations) or foreign laws, plus proof that withholding in fact occurred, before applying this exclusion.
56Common Audit Issues for Cross-Border Workers: Expatriate Withholding – Employer Response Some employees file Forms W-4 claiming “exempt status” – and the IRS scrutinizes these forms, and the updates to the forms (required every February) very carefully.Here again, many of the criticisms are contradicted by the I.R.M. and the W-4 form instructions, which indicate that the form is NOT invalidated completely if both “exempt status” and a high number of exemptions are claimed, and also permit reliance on prior-filed Forms W- 4 with high numbers of exemptions.
57Common Audit Issues for Cross-Border Workers: Expatriate Withholding – Employer Response Many examining agents, in calculating proposed taxes, apply the highest possible effective marginal rates, instead of applying the 25% supplemental rate (which admittedly jumped to 39.6% in 2013 for supplemental wages over $1M). This violates instructions in the I.R.M.Moreover, agents sometimes use the 25% supplemental rate in computing adjustments, when in fact the regular wage rate would have been less.Thus, in any audit, agents tend to use the higher of the regular marginal rate or the supplemental rate, when they should use the lower of the two rates.
58Common Audit Issues for Cross-Border Workers: Expatriate Withholding – Employer Response An employer’s Code § 3403 liability for non-withheld taxes can be abated, pursuant to Code § 3402(d), if “the tax against which such tax may be credited is paid.”According to Treas. Reg. § (d)-1, “the employer will not be relieved of his liability for payment of the tax required to be withheld unless he can show that the tax … has been paid.”One potential method of proof is the Form 4669 – but other methods should be available, as discussed below.
59Common Audit Issues for Cross-Border Workers: Expatriate Withholding – Employer Response The I.R.M. does not limit Form 4669 as the exclusive method by which an employer can “show that the tax … has been paid.”It simply provides one manner in which an employer can make a prima facie showing that an employee paid the underlying tax.Alternative forms of satisfying the Code § 3402(d) abatement rules have been recognized in numerous court cases.
60Common Audit Issues for Cross-Border Workers : Expatriate Withholding – Employer Response Alternative forms of proof include:Providing records relating to affected employees for whom the employer’s accountant prepared U.S. federal income tax returns, pursuant to the employer’s expatriate employee benefits program;Providing information return filing records;Providing a list of the names and SSNs of the affected employees, along with a statement that the employer has maintained records of: (1) each affected employee’s Form W-2 (and, if applicable, Form W-2c); (2) payment to the accounting firm for tax return preparation and filling fees; and (3) a tax equalization computation; orProducing records evidencing the costs of preparing each employee’s tax return and related tax equalization computations.
61Best Practices to Avoid Expatriate Withholding Issues? What forms should be completed by employee?What are the “Do’s and Don’t’s” of completing Forms W-4 and other election forms?What questions should be resolved in written assignment letters?What steps should be taken to track equity compensation vesting?
62Common Audit Issues for Cross-Border Workers: Impatriate Withholding Issues For impatriates, different rules apply.Code § 861 provides only a limited exclusion (for under $3,000 of income, and for work of under 90 days) for services performed in the U.S.The IRS counts even a minute of a calendar day as a full day, even though the regulations indicate that the calendar day test is a “general” rule (implying that exceptions exist).In a pending Tax Court case, American Airlines v. Comm’r, the IRS examining agents proposed to count stays of under 24 hours by flight attendants as “two, and possibly three days” – ignoring Tax Court precedent that would ignore de minimis short-term stays.Note: This American Airlines case presents interesting procedural issues re: the ability to litigate payroll tax cases in the U.S. Tax Court where there is a dispute about the application of Section 530, even if the IRS has not issued a “Notice of Determination of Worker Classification.”
63Common Audit Issues for Cross-Border Workers: Impatriate Withholding Issues Income tax treaties (in place with nearly 60 countries) also provide a general exemption from U.S. income taxes for amounts received by nonresident aliens who travel to the U.S. for study, research, or business or technical training (which is precisely why many B-1 visa-holders travel to the U.S.).However, these treaty exemptions do not apply to persons actually working in the U.S. (e.g., employees traveling on L-1, TN, or H-1B visas).Note: Some IRS agents examine even employees on B-1 visas, attempting to prove that the visas were obtained in error, and that the employees are ineligible for treaty protections.
64Common Audit Issues for Cross-Border Workers: Impatriate Withholding Issues For these NRA workers, whose income and period of stay likely exceeds the Code §861 exclusion limits, many employers arrange to pay their U.S. taxes (even though the foreign entity pays their wages), typically depositing the taxes on a quarterly basis, and then following through with tax return preparation.However, in some audits, the IRS has alleged that the U.S. employer’s payments of taxes are late-deposited, thus triggering FTD penalties under Code §6656 (even though the U.S. employer never in fact paid the wages).This issue is pending in several appeals.
65Common Audit Issues for Cross-Border Workers: Impatriate Withholding Issues FICA/FUTA taxes also apply (since the exception – discussed below) for work performed for “non-American employers” applied only to work performed outside the U.S.Unfortunately for many of these NRA workers, they may never qualify for social security or unemployment benefits, but the IRS ignores the basic unfairness of imposing these social taxes, where no benefits will be received.On the other, some workers (e.g., the flight attendants in the American Airlines case) may qualify for lifetime post-retirement benefits, after paying minimal FICA, but there again the IRS attorneys have indicated that “receipt or nonreceipt of social security or unemployment benefits is irrelevant to us.”
66Common Audit Issues for Cross-Border Workers: Impatriate Withholding Issues FICA taxes are imposed on “all remuneration for employment ….”Code § 3121(b) defines “employment” to include:Any service performed within the United States (irrespective of the citizenship or residence of the worker or the service recipient); and“Any service, of whatever nature, performed outside the United States by a citizen or resident of the United States as an employee for an American employer.”Code § 3121(h) defines “American employer” to include a “corporation organized under the laws of the United States or of any State.”Where NRA employees work outside the U.S. for CFCs –corporations organized under the laws of foreign countries – FICA taxes are not applicable if the CFCs are not “American employers.”
67Common Audit Issues for Cross-Border Workers: Impatriate Withholding Issues This exception for “non-American employers” does not apply to any work performed in the U.S.However, some wages earned in the U.S. qualify for the totalization tax treaty exemption from FICA (applicable where (and only if) certificates of coverage are obtained).For employees whose wages are not exempt under §861 or a treaty, many employers do withhold FITW (and FICA, if applicable),for foreign employees working in the U.S. who are paid by the U.S. affiliate during their stay.Unfortunately, the IRS is challenging both the payment and the nonpayment of payroll taxes for these impatriate employees.
68Common Audit Issues for Cross-Border Workers: Impatriate Withholding Issues For employers who have withheld and deposited FICA (as well as other payroll taxes), as noted above, the IRS has alleged that the FICA-taxes are “late-deposited,” and has proposed FTD penalties.This penalty is hard to justify, since the U.S. employer in many instances did not pay the wages in the first instance, and no FTD penalties can be applied to an employer that has not withheld (and, as a practical matter, has not even paid the wages).This issue is also still pending in several IRS appeals.
69Common Audit Issues for Cross-Border Workers: Impatriate Withholding Issues For employees whose wages likely exempt under §861 or a treaty, where no payroll taxes are paid, the IRS has announced in several audits that it intends to audit the foreign affiliate, even though:the U.S. has no jurisdiction over the foreign employer;the U.S. affiliate cannot be held liable for underwithheld taxes, except for certain government contractors affected by Code § 3121(z); andIt is very hard to obtain the information, given strict procedures for seeking and obtaining foreign records, and limitations on information exchanges (on top of IRS budget limitations on traveling to the foreign countries).
70Common Audit Issues for Cross-Border Workers: Impatriate Withholding Issues It is possible, in opening audits of these foreign affiliates of U.S. employers, that the IRS is only trying to collect unpaid employment taxes (for workers with compensation not exempt under Code §861 or a treaty).It is also possible that the IRS is trying to determine visa violations, which it could report to US immigration authorities.Finally, it is possible that the IRS is trying to prove that the foreign affiliates have created a “permanent establishment” in the U.S.The IRS’s motives are not as yet very clear, since most of these foreign affiliate audits are in early stages.
71Common Audit Issues for Cross-Border Workers: Impatriate Withholding Issues Additional problems arise when NRA employees (or green card holders) move back overseas and exercise option or receive other equity compensation (e.g., RSUs), since at least FICA withholding, and possibly also income tax withholding, applies to that compensation attributable to U.S. services, irrespective of the fact that the employees are working for non-American employers at the point the compensation is ultimately received.
72Common Audit Issues for Cross-Border Workers: Impatriate Withholding Issues In sourcing income from options and other equity compensation, the U.S. generally applies the grant-to-vest method. See Treas. Reg. § (b)-(d).However, this is not the exclusive method, as source-of-income allocation must turn on the specific facts and circumstances of the particular case.An alternative to the grant-to-vest method allocates income based upon the taxpayer’s residence during the period of significant appreciation in the underlying stock.Many agents also make mistakes in their computations, counting income from equity grants after leaving the U.S.
73Common Audit Issues for Cross-Border Workers: Impatriate Withholding Issues Since the IRS has never issued adequate guidance supporting the application of U.S. payroll taxes to non- citizens employees who have moved back overseas, the principles outlined in the “Confusion Doctrine” bar the IRS from imposing FICA taxes on employers.See Central Illinois Public Service Co. v. U.S., 435 U.S. 21 (1978) (waiving liability for payroll taxes, where the IRS has never issued guidance or outlined clear rules governing the computation and collecting of payroll taxes).
74Best Practices to Avoid Impatriate Withholding Issues? What forms should be completed by employee (e.g., Forms W-2, collection of Certificates of Coverage (if applicable) under foreign social security system, and Forms 4669??What questions should be resolved in written assignment letters?Are secondment agreements advisable? Note: in OECD commentary issued in 2012, the OECD has made clearer that the adoption of secondment agreements – which allow multinationals to put personnel in countries without separating them from their formal employers (typically with with cost-plus charges to the local affiliate) – can minimize the PE risk.What are the “does and don’ts” of entering into secondment agreements?
76Wage Recharacterization Audits: Choices between Cash and Code § 132(d) Benefits Background:Many financial institutions over recent years have cooperated with requests from their senior financial advisors and certain executives to allow the employees to establish reimbursement accounts, “funded” in part by the employee’s agreement to forgo certain amounts – typically percentages of future compensation.Typically these reimbursement plans are established before the employee has any right to any specific amount of future compensation.Other industries employing high percentages of traveling workers have similar trade-offs between travel expenses and taxable wages.The IRS is now challenging these “wage recharacterization” plans in dozens of audits – particularly in the travel nursing industry.
77Wage Recharacterization Audits: Choices between Cash and Code § 132(d) Benefits Code § 132(a) provides that gross income shall not include any fringe benefit that qualifies as a “working condition fringe,” defined as any property or services provided to an employee of the employer to the extent that, if the employee paid for such property or services, such payment would be allowable as a deduction under Code § 162.Cash payments to an employee can also qualify as a working condition fringe benefit, per Treas. Reg. § (a)(1)(v).
78Wage Recharacterization Audits: Choices between Cash and Code § 132(d) Benefits Despite this general exclusion for working condition fringes, there are limitations on structuring choices between fringe benefits and cash, on establishing expense arrangements that are funded out of future employee earnings, and on paying “travel expenses” which appear to be substituted for taxable wages.However, the IRS’s “prohibition” of employee choices between cash or Code § 132 benefits (including working condition fringe benefits) is very confusingly drafted.
79Wage Recharacterization Audits: Choices between Cash and Code § 132(d) Benefits Specifically, Treas. Reg. § (a)(1)(i) provides as follows:– A service or property offered by an employer in connection with a flexible spending account is not excludable from gross income as a working condition fringe. For purposes of the preceding sentence, a flexible spending account is an agreement (whether or not written) entered into between an employer and employee that makes available to the employee over a time period a certain level of unspecified non-cash benefits with a predetermined cash value.No IRS guidance explains or illustrates this rule.Even the 2012 ruling (discussed below) does not cite it.
80Wage Recharacterization Audits: Choices between Cash and Code § 132(d) Benefits In addition, the proposed regulations under Code § 125 (re-proposed in August 2007) specifically provide that Code § 125 is the exclusive means by which an employer can offer employees an election between taxable and nontaxable benefits without the election itself resulting in inclusion in gross income by the employees. See Prop. Reg. § (b).If a plan does not meet the requirements of the proposed regulations, the employee will be taxed on the value of the taxable benefit regardless of what benefit is elected and when the election is made. Id.
81Wage Recharacterization Audits: Choices between Cash and Code § 132(d) Benefits The proposed regulations prohibit offering fringe benefits in Code § 132, including working condition fringe benefits, through a Code § 125 cafeteria plan. See Prop. Reg. § (q).The scheduled effective date for these proposed regulations was plan years beginning on or after January 1, See Prop. Reg. § (s).The IRS has never finalized these proposed regulations.Until proposed regulations are formally adopted, they carry no more weight than a position advanced on brief by the IRS. See F. W. Woolworth Co. v. Comm’r, 54 T.C. 1233, (1970).
82Wage Recharacterization Audits: Choices between Cash and Code § 132(d) Benefits The IRS has changed its position numerous times over the last 20 years as to when and whether expense accounts might be effectively arranged for by agreement to reduce future bonuses.See P.L.R (elective commission reduction to place specified amounts in a reimbursement account not an “accountable plan”);In both P.L.R and in an unpublished 1998 field service advice, F.S.A , issued to the IRS district director in connection with an audit of a travel-licensed clinician staffing company, the IRS concluded that a mandatory nonelective reduction of pay and establishment of a reimbursement arrangement satisfied the “accountable plan” and Code § 132(d) rules.82
83Wage Recharacterization Audits: Choices between Cash and Code § 132(d) Benefits In P.L.R , the IRS ruled that an elective salary reduction arrangement to set up an expense reimbursement plan satisfied the “accountable plan” rules, but then nine months later, in P.L.R , the IRS announced that it was “reconsidering” that conclusion.The “reconsideration” did not extend to nonelective arrangements.No P.L.R. has ever been issued on agreements to reduce compensation before it is earned, and to receive specified noncash fringe benefits and expense reimbursements.83
84Wage Recharacterization Audits: Choices between Cash and Code § 132(d) Benefits Taxpayers have won two cases in which the facts showed that local employees (who did not receive per diems and travel expenses) were paid higher wages than traveling employees, who were reimbursed for expenses.Trucks, Inc. v. U.S., 234 F.3d 1340 (11th Cir. 2000), reversing and remanding 987 F. Supp 1474 (N.D. Ga. 1997).Worldwide Labor Support of Mississippi, Inc. v. U.S. 312 F.3d 712 (5th Cir. 2002), vacating and remanding U.S.T.C. ¶50,463.84
85Wage Recharacterization Audits: Choices between Cash and Code § 132(d) Benefits At a 2007 meeting of the Fringe Benefit Tax Section of the American Bar Association, IRS attorneys present conceded that there were practical difficulties with enforcing an absolute prohibition on wage recharacterization; they also admitted that if an arrangement was properly structured, it would be unlikely to be challenged by the IRS on audit.In 2008, some Treasury Department attorneys admitted that the proposed cafeteria plan regulations “are overbroad” and should be revised so as not to attempt to block all choices made by employees among different types of benefits.85
86Wage Recharacterization Audits: Choices between Cash and Code § 132(d) Benefits In a significant recent reversal of its prior reluctance to challenge wage recharacterization, on September 10, 2012, the IRS issued Rev. Rul , providing various examples of prohibited wage recharacterization – most in the context of per diem travel expense reimbursement plans.Three examples in Rev. Rul (for cable installers, travel nurses, and construction workers) conclude that plans provide all taxable benefits, where employees’ taxable wages have been reduced to accommodate tax-free allowances for travel and job-related expenses.86
87Wage Recharacterization Audits: Choices between Cash and Code § 132(d) Benefits One example in Rev. Rul allows prospective wage reductions for all employees in a housecleaner workforce, coupled with a reimbursement plan for workers documented expenses.Rev. Rul does not address the prospective establishment of different amounts of salary reduction (and different sizes of reimbursement accounts) for different employees, nor does to address how frequently a reimbursement arrangement might be modified.It is unclear whether the IRS will use this 2012 revenue ruling to challenge choices by financial industry employees between wages and working condition fringes.87
88Wage Recharacterization Do’s and Don’ts Advisable Protections for Establishment of Any Salary-Choice Reimbursement Plans:Require determination of expense reimbursement budget well before the employee’s right to the compensation has “ripened,” and while the amount to be received is still speculative.The compensation reduction should be some percentage of as yet unaccrued, undetermined future compensation, so that the account is not funded with a “pre-determined” amount in violation of Treas. Reg. § (a)(1)(i).The accounts should cover pre-specified types of reimbursable business expenses—again to avoid any violation of Treas. Reg. § (a)(1)(i) (which prohibits the establishment of accounts to pay fixed amounts of “unspecified noncash benefits”).
89Wage Recharacterization Do’s and Don’ts The “give up” of compensation should occur at specific times —preferably before the year in which the future compensation will be earned.The assigning employee must forfeit all rights to the assigned compensation—absolutely no reversion of unspent amounts.The employer should have discretion to make the final determination of the reimbursement amounts.Consider obtaining opinion of outside counsel confirming the arrangement’s compliance with tax rules.
90Wage Recharacterization Do’s and Don’ts Arguments Supporting Legitimacy of Such Assignments:No violation of the regulations under Code §§ 132(d) or 62(c).They comply with the Lucas v. Earl prohibition (also discussed below) on assignments of “ripened” rights to income.No constructive receipt of any compensation under Treas. Reg. § § and -2; Rev. Rul , because the assigning employee never had any immediate or “current” right to any specific amount.See Trucks, Inc. and Worldwide Labor Support (cited above.
91Wage Recharacterization Do’s and Don’ts Steps Not to Take in Designing an Expense Reimbursement Plan.Don’t pay tax-free reimbursements for any expenses that are already covered under a per diem arrangement or to persons receiving tax free lodging in kind.Don’t offer cash options.Don’t allow pay per diem allowances, regardless of whether or not the worker travels away from home on the employer’s business.Don’t pay expenses on non-travel days.Don’t pay amounts exceeding Federal per diem rates.Don’t pay per diems on an hourly basis (or otherwise “on the same basis as other wages”).
92State and Local Tax Developments FOR MOBILE WORKFORCE EMPLOYERS
93Topics Covered Current State Rules Mobile Workforce State Income Tax Simplification ActVoluntary Compliance ProgramsNY MTA Payroll Tax Refund ClaimsFederal Protections
94I. Current State Rules: State Taxation of Workers in Multiple States & Employer Withholding ObligationsCompanies with peripatetic workforces—employees and contractors working in, and moving among, many different states, either in a single year or over the course of the vesting period for bonuses, stock options, restricted stock, or other equity compensation—have special problems due to myriad state laws governing the taxation of residents and non-residents.
95State Taxation of Workers in Multiple States: Impediments/Opposition Form W-2 includes spaces in Boxes at the bottom of the Form for reporting income to two different states (separated by a broken line).The IRS instructions to Form W-2 say, “If you need to report information for more than two states or localities, prepare a second Form W-2.”Payroll systems may not accommodate (or capture) multiple work locations.But employees almost invariably complain if employers report wages in more than one state.
96State Taxation of Workers in Multiple States: Employer Withholding The “employer nexus” to trigger withholding, for most states is:Employer office in state, or some other nexus to trigger state income tax; andPayments of any wages subject to income tax in the state (or subject to contribution under the state’s unemployment compensation laws).
97State Taxation of Workers in Multiple States: Employer Withholding Some states provide thresholds before withholding is triggered, based on days worked, dollars earned, or some combination of the two. (See map on following slide.)Examples:NY – reasonable expectation that employee will work 14 days or less in NYGA – 23 days a quarter, or GA-allocated wages exceeding 5% of total compensationCT – 14 working days a yearND – 20 working days a year
98Overview of Thresholds WAMEMTNDORMNIDWIVTNHSDNYWYMIMACTIAPARINVNENJUTILINOHCAAKCODEKSMOWVVAMDKYNCAZTNNMOKARSCMSALGATXLAHIFLNonresident employees subject to tax withholding on first day of travelNonresident employees subject to tax withholding after reaching thresholdNo general personal income tax (or, in the case of Washington, DC, no tax on nonresidents)
99State Taxation of Workers in Multiple States: Risks of Employer Audits As with any payroll audits, it is simpler for state/local tax officials to audit employers, holding them liable for non-withheld income taxes where allocated wages exceed the state’s personal exemption, because that is more efficient than finding and auditing individual employees.If employers have neither reported nor withheld on the income, it is extremely unlikely that any non-resident of a state would have voluntarily paid income taxes (thereby enabling the employers to abate their liability for nonwithheld income taxes).
100State Taxation of Workers in Multiple States: Risks of Employer Audits However, it is nearly impossible for employers to keep track of day-counting income allocation rules (or with 183+ days residency tests).Some states have poorly explained rules on income allocations.Historically, many states were not aggressive in auditing non-residents or conducting payroll audits.Some states (e.g., NY) have been operating “amnesty programs” or “Voluntary Disclosure Agreements” to encourage employers to voluntarily confess their withholding/reporting errors.
101State Taxation of Workers in Multiple States: Some NY Horror Stories Part-Day Counting: Any portion of a day in NY can trigger allocation of income to NY. See Matter of Holt, DTA No (2007) (“petitioner [a Florida resident] finds it incredible that an individual's presence in New York for a portion of a day constitutes a day for New York tax purposes”).No Minimum Number of Days: Many states have some minimum number of days of work in a particular state before state income-allocation rules apply. NY does not.
102State Taxation of Workers in Multiple States: Some NY Horror Stories Meeting Burden of Proof to Show Non-Resident Status: In In the Matter of Julian H. and Josephine Robertson, NY DTA (2009 and 2010), NY auditors had maintained that a couple had been in NY for 183 days and that the taxpayers’ records showing time outside NY were inadequate for 4 days, and thus the taxpayers, as NY residents for more than 183 days, would owe additional NY City taxes totaling $26,702,341 for 2000.After an extensive trial, in a 100+ page opinion, the judge believed the taxpayers’ testimony; after an exception was filed, the case was argued again, another opinion was issued, and the taxpayers won again.But see Puccio, NY DTA (2011).
103State Taxation of Workers in Multiple States: Some NY Horror Stories “Convenience of Employer” Rule: NY counts even services performed by any NY non-resident at the taxpayer's out-of-state home that could have been undertaken at the employer's office in NY, unless the services were performed out of state for the employer’s necessity, not the employee's convenience. (20 NYCRR section (a). See, e.g., Matter of Phillips v. New York State Department of Taxation and Finance, 267 AD2d 927, 700 NYS2d 566, lv denied, 94 NY2d 763, 708 NYS2d 52, Matter of Page v. State Tax Commission, 46 AD2d 341, 362 NYS2d 599; Matter of Simms v. Procaccino, 47 AD2d 149, 365 NYS2d 73), Matter of Zelinsky v. Tax Appeals Tribunal of State of New York, 1 NY3d 85, 769 NYS2d 464, cert denied 541 US 1009, 158 L Ed 2d 619), In the Matter of the Petition of Manohar and Asha Kakar, DTA No (Feb. 16, 2006), and Matter of Huckaby v. New York State Division of Tax Appeals, 4 NY3d 427, 796 NYS2d 312, cert denied 546 US 976, 126 S Ct 546, 163 L Ed 2d 459).
104State Taxation of Workers in Multiple States: Some NY Horror Stories See Edward A. Zelinsky, “New York’s ‘Convenience of the Employer’ Rule Is Unconstitutional,” State Tax Notes Doc (“New York’s ‘convenience of the employer’ doctrine has not fared well in the court of professional opinion.”).These harsh results are one of the drivers behind efforts to enact federal blockers on states’ abilities to tax non-residents. (See discussion below.)
105State Taxation of Employers Due to Telecommuting Employees Telebright – New Jersey Appellate Division found company subject to income tax based solely on presence of one telecommuting computer programmer.Company did not care where employee worked.Employee was originally based outside NJ, but asked to continue employment after moving there.No solicitation/marketing activities in NJ.Employee’s daily presence in NJ for the purpose of carrying out her responsibilities as an employee was sufficient to satisfy the substantial nexus requirement of the Commerce Clause.See Warwick McKinley, Inc., Cal. SBE
106State Taxation of Workers in Multiple States: Stock Option/SAR Allocation Methods The state rules governing the taxation of stock options (or SARs) and the income allocation withholding rules for option income received by non-residents vary greatly depending on the state (and some states have never adopted any option-sourcing rules):Grant-to-Vest Method: Taxes option exercise income based on the percentage of time in the state between the date of grant and the date the options vest;Grant-to-Exercise Method: Taxes option exercise income based on the percentage of time between the date of grant and the date the options are exercised;Year-of-Exercise Method: Option spread from exercise is taxable only if services were performed during the year of exercise and not over a multiyear period;Degree of Appreciation Method: Allocates the income based on the amount of appreciation of the underlying option that occurred while the taxpayer was a resident of the state.The variance between the states, and from year to year within certain states, clearly suggests there is no set rule, and the most appropriate method is to allocate the income based on a reasonable facts and circumstances analysis.
107II. Mobile Workforce State Income Tax Simplification Act (aka “Marketplace Fairness Act”) This bill would address the taxation of non-resident employees (excluding professional athletes, professional entertainers, and some public figures) and would set a threshold of days below which a state could not subject the non-resident to state income tax.H.R passed the U.S. House of Representatives on May 15, 2012.H.R. 1129, containing language identical to H.R. 1864, was reintroduced to the House and referred to the House Committee on the Judiciary on March 13, Its lead sponsors are Reps. Howard Coble (R-NC) and Hank Johnson (D-GA), plus 28 more House cosponsors.S. 1645, the corresponding Senate bill, was introduced in November 2013, by an impressive list of bipartisan original cosponsors, including Senators Sherrod Brown (D-OH) and John Thune (R-SD) (both on Senate Finance).For information about the 254-member coalition of supporters, contact Maureen Riehl at
108Mobile Workforce State Income Tax Simplification Act Establishes a 30-day threshold that non-residents would have to work in a state before becoming subject to out-of-state taxesStrong state oppositionThe initial bills had proposed a 60-day threshold, but because of state clamor a compromise was reached between employers and states, and in the most recent version of the bill a 30-day threshold was proposed.
109Mobile Workforce State Income Tax Simplification Act A “day” is attributed to the state where an employee performs more of his employment duties compared to another state, UNLESS, the employee performs employment duties in a resident state and ONLY one non-resident state during one day. In this case the employee will be considered to have performed more of the duties in the non-resident state.Incentive to visit two states in a travel dayRecordkeeping issuesUnclear whether it simplifies anything
110Mobile Workforce State Income Tax Simplification Act In testimony before the House Committee on the Judiciary on May 25, 2011, the President of the Federation of Tax Administrators (FTA) opposed H.R. 1864, arguing that:The 30-day rule should count work for any part of a dayA dollar threshold should be added so that highly paid employees might be subjected to withholding for less than 30 days of workStock options and multiyear compensation should be exemptedThe House Committee on the Judiciary approved H.R on November 17, 2011 after rejecting changes proposed by Rep. Nadler (NY), but recognizing that changes may be required to respond to the FTA’s concerns.
111MTC Model StatuteThe Multistate Tax Commission (MTC) has proposed a mobile workforce withholding and individual income tax model statute that would decrease the threshold to 20 days. The MTC’s model statute provides that MOST non-residents’ income from work performed in states of non-residence would be exempt from withholding if the non-residents:have no income derived from the non-resident states;worked fewer than 20 days in such states (days in transit would be exempt from the day count); andreside in states that have reciprocal exemptions or do not impose personal income taxes.
112MTC Model StatuteCertain workers would be excluded from the withholding protections provided by the MTC’s model statute:professional athletes;persons of prominence who perform services on a per-event basis;professional entertainers;construction laborers; andkey employees.
113MTC Model StatuteUnder the MTC’s model statute, qualifying employees would not have a filing requirement in the state of nonresidence; and employers would not have a withholding requirement regarding qualifying employees.However, the model act does not explicitly address nexus issues for employers with no nexus to the state.Also, states with “income thresholds” instead of day-counting thresholds (e.g., Montana) have criticized the MTC's model statute and its “days of working presence” test for creating problems for states that have an income threshold for taxability. They also note that high-earner non-residents working less than 20 days would be exempt from filing returns, while lower-paid non-residents working more than 20 days in a state would have to file.
114Telecommuter Tax Fairness Act First introduced in 2004, and most recently introduced in November 2011 (S. 1811, 112th Cong.) – Would bar states from adopting a “convenience of the employer rule,” and require that an employee be physically present in the state as a precondition to imposition of tax on that worker.
115III. Voluntary Compliance Opportunities As noted previously, many states have voluntary disclosure agreements and/or temporary amnesty programs.Processes and requirements are not consistent.Limitation of look-back period and penalty reliefNew York has a streamlined program.California has both a voluntary compliance program and a filing compliance agreement program.Other states
116Voluntary Compliance Opportunities Given the heightened focus on audits and unreasonableness of the one-day rule in certain states, we are seeing many clients take advantage of these programsTypically anonymousFormal agreementCorrection programs have worked for executive groups and have eliminated the need to file individual returns.
117IV. NY MTA Payroll Tax Refund Claims Employers in New York City and several surrounding counties have paid a 0.34% payroll tax since 2009 on the wages and certain other compensation paid to employees employed within this “Metropolitan Commuter Transportation District.”Although several prior challenges to the legality of this MTA Payroll Tax had failed, on August 22, 2012, the 10TH District of the NY State Supreme Court struck down this “mobility tax,” on grounds that it had been enacted without first obtaining the constitutionally required prior approval of local legislative bodies (a “home rule message”), or, alternatively, approval under a “message of necessity” by 2/3 of each NY legislative house.
118NY MTA Payroll Tax Refund Claims Although this ruling in Mangano, et al. v. Silver, et al., N.Y. S. Ct., No /10, is being appealed, any employers that have been paying this payroll tax may file “protective” refund claims.On October 17, 2012, the New York State Department of Taxation and Finance published guidance regarding the procedures for taxpayers to file these refund claims.See proceedings.htmand the claim form, at https://www8.tax.ny.gov/MCPC/mcpcStartSome employers estimate that their refunds could exceed $1 million.118
119V. Federal Protections: Federal Blocker of State Taxation of Certain Retirement Income of Former State ResidentsSince 1996, 4. U.S.C. § 114 has prohibited states from imposing an income tax on “qualified retirement plan income” and certain other types of non-qualified deferred compensation benefits paid to any individual who had earned the income while working in one state (either as a resident, domiciliary, or part-time worker) but had retired and moved out of the source state before the income was paid.
120Federal Blocker of State Taxation of Certain Retirement Income of Former State Residents These rules were lobbied into the “interstate commerce” section of the Federal Code in 1996 by RESIST (Retirees Eliminating State Income Source Taxation), the American Payroll Association, and other affected mobile workforce employees.The rules were later extended to certain retired partners (as described in Code § 7701(a)(2)) who have “retired” under their partnership agreements.
121Federal Blocker of State Taxation of Certain Retirement Income of Former State Residents There will never be federal regulations because no federal agency would undertake such a project.There are some states that have issued regulatory guidance, and some that have issued private rulings on the rules’ application.
122Federal Blocker of State Taxation of Certain Retirement Income of Former State Residents The definition of “retirement income” that cannot be taxed when earned by non-residents generally includes the following items:Qualified retirement plans;Excess benefit plans or wrap-around plans; andCertain other forms of nonqualified deferred compensation described in Code § 3121(v)(2) paid out in equal periodic installments over at least a 10-year period or for a recipient’s life or life expectancy.
123Federal Blocker of State Taxation of Certain Retirement Income of Former State Residents The excepted payments from “Qualified Retirement Plans” include:§ 401(k) plans;§ 408(k) simplified employee pensions;§ 403(a) annuity plans;§ 403(b) annuity contracts;§ 7701(a)(37) individual retirement accounts;§ 457(a) eligible deferred compensation plans;§ 414(d) governmental plans;Military retired or retainer pay plans; and§ 501(c)(18) employee contribution trusts.
124Federal Blocker of State Taxation of Certain Retirement Income of Former State Residents “Excess benefit plans or wrap-around plans” are defined as:Plans solely for the purpose of providing retirement benefits for employees in excess of the limitations imposed by one or more of Sections 401(a)(17), 401(k), 401(m), 402(g), 403(b), 408(k), or 415 of such Code or any other limitation on contributions or benefits in such Code on plans to which any of such sections apply.The description of these plans in the legislative history references a statute before it was amended in conference, which confuses interpretation of this provision.
125Federal Blocker of State Taxation of Certain Retirement Income of Former State Residents The final exception encompasses other forms of nonqualified deferred compensation described in Code § 3121(v)(2) paid out in equal periodic installments over at least a 10-year period or for the recipient’s life or life expectancy.Directors and independent contractors are not eligible for this exception because SECA taxes have no corollary to 3121(v)(2). We are waiting to see if a petition is filed, or a settlement offer is proposed.Retired partners have special statutory protections added to the Federal statute in 1996.
126Federal Blocker of State Taxation of Certain Retirement Income of Former State Residents Presumably the determination of whether distributions meet the “substantially equal periodic payment” rule would be determined by Reg. §1.402(c)2, Q&Q 5(a) (providing that the determination is made at the annuity starting date, and is not affected by subsequent contingencies and modifications, such as death of a participant) and Q&A 5(d) (specifying that distributions over ten years can be paid under a “declining balance of years” method, which pays 1/10 in year 1, 1/9 of the remainder in year 2, etc.).
127Federal Blocker of State Taxation of Certain Retirement Income of Former State Residents The Code § 3121(v)(2) regulations expressly exempt stock options, stock appreciation rights, restricted stock, severance, sick leave, compensatory time, and vacation pay.Stock options, SARs, and restricted stock could not be paid out over 10 years or as an annuity in any event.Code § 409A has significantly limited application of this exception by barring most changes in deferred compensation distribution schedules.
128Federal Blocker of State Taxation of Certain Retirement Income of Former State Residents Since Code § 3121(v)(2) applies only to common law employees, it is not clear whether this provision applies to corporate directors or other non-employees (excepting certain retired partners who are covered by a later statutory expansion of this federal source tax legislation).
129Additional Specialized Federal Blockers of State Taxation of Transient Non-Resident Workers Congress has enacted several industry-specific laws that fully or partially block states from mandating withholding on wages of certain non-resident employees of certain types of employers:Railroads – 49 USC §11502 (4-R Act);Airlines – 49 USC § (Anti-Head Tax Act);Motor Carriers – 49 USC §14503;Fishing vessels, or vessels engaged in “foreign, coastwise, intercoastal, interstate, or noncontiguous trade” – 49 USC §
130IRS and Independent Contractors: Basic Questions Audit Who are Independent Contractors (ICs)?What are the Applicable IRS Tests?Who are the Stakeholders?Why does Employee/IC Status Matter?What are the Financial Stakes?The Tax Relief ProvisionsBest Practices and Methods to Reduce ExposureIRS Information Sharing with the DOL and the states (including particularly California)_1.PPTX
131IRS and Independent Contractors: Audit Triggers and Audit Developments Increased requests for post-termination Form 1099 reporting (including in settlements);automatic review of all information reporting where the same worker received a Form W-2 and a Form 1099.requests for withholding on director fees (and pending legislation on this issue); andbackup withholding audits (involving both alleged underwithholding, and penalties for non-filing of Information returns)._1.PPTX
132IRS and Independent Contractors: Audit Triggers and Audit Developments California worker classification audits;Developments in ability to take worker classification cases to Tax Court (which historically had not had jurisdiction over payroll taxes)._1.PPTX
133Employee or Independent Contractor? Common Law EmployeeIndependent ContractorLeased EmployeesJoint Employment/Co-EmploymentDual-Status WorkersCorporate Officers and Other “Statutory Employees”“Statutory Nonemployees”Section 218 Agreement Employees_1.PPTX
134Employee Misclassification: Government Stakeholders Federal and State Agencies Affected by Employee MisclassificationAgencyAreas potentially affected by employee misclassificationIRSFederal income and employment (payroll) taxesDOLMinimum wage, overtime, and child labor provisionsJob protection and unpaid leaveSafety and health protectionsImmigration/Form I-9 issuesIRS, DOL and PBGCPension, health, and other employee benefit plansDepartment of Health and Human ServicesMedicare benefit paymentsEEOCProhibitions of employment discrimination based on factors such as race, gender, disability, or ageNLRBThe right to organize and bargain collectivelySSARetirement and disability coverage and paymentsState AgenciesUnemployment insurance benefit paymentsState income and employment taxesWorkers’ compensation benefit payments_1.PPTX
135Employee or Independent Contractor: The Common Law Test 20-Factor Testinstructionsorder or sequences setintegrationreportspaymentsexpensestraininginvestmentservices rendered personallytools and materialshiring assistantsprofit or losscontinuing relationshipworks for more than one person or firmset hours of workoffers services to general publicfull-time workright to dischargework done on premisesright to quit_1.PPTX
136Independent Contractor Tests: IRS Three-Factor Test For audit purposes, IRS auditors use a modified version of the 20-Factor Test that focuses on three factors:Behavioral Control FactorsFinancial Control FactorsRelationship of the Parties FactorsIRS Three-Factor Test considers the work that is being performed and the business context in which it is being performed_1.PPTX
137Why Does It Matter? Benefits and Business Expenses Differences Among Benefits ResponsibilitiesType of BenefitsEmployeesIndependent ContractorsRetirement plansEmployers sponsor benefit plansEmployers and employees contributeContractors sponsor plansContractors bear the full financial cost of the plansHealthcareEmployers sponsor on a tax-free basisContractors obtain coverageContractors bear the full financial cost, but receive a tax deductionReimbursed expenses/accountable plansEmployers can reimburse expensesNontaxable to the extent they are paid under an accountable planService recipient can reimburse, although expenses are generally unreimbursedReimbursed expenses are nontaxable if they are under an accountable planUnreimbursed expensesMany employers don’t fully reimburse expensesUnreimbursed expenses are subject to a 2% floor and AMTBusinesses don’t generally reimburse expensesNot subject to a 2% floor or AMT_1.PPTX
138Why Does It Matter? Payroll Taxes Differences Among General Tax ResponsibilitiesEmployeesIndependent ContractorsType of TaxBusinesses' general responsibilitiesWorkers' general responsibilitiesFederal income Tax Withholding (FITW)Withhold tax from employees' payPay full amounts owed, generally through withholdingGenerally, nonePay full amounts owed, generally through estimated tax paymentsSocial Security and Medicare Taxes (FICA)Withhold one-half of taxes from employees' pay and pay other halfPay half of total amounts owed, generally through withholdingNoneFederal Unemployment Taxes (FUTA)Pay full amountState Unemployment Taxes (SUTA/SUI)Pay full amount, except in certain statesNone, except pay partial amount in certain states_1.PPTX
139Why Does It Matter? Payroll Taxes and the Tax Gap (Billions)$5 billion associated with FICA/FUTA$51 billion-$56 billion associated with SECAOther estimates place the annual “Employment Tax Gap” at $15 billion (IRS, in introduction of NRP program), $54 billion (Treasury study issued 9/26/06), or up to $78 billion._1.PPTX
140Why Does It Matter? Payroll Taxes Full-rate Federal statutory liability equal to at least 40% of compensation payments to independent contractors25% FITW exposure15.3% Employer and Employee FICA (Social Security and Medicare)*Social Security Taxable Wage Base ($110,100 for 2012)Interest-free adjustments and rarely impose penaltiesFull-rate state liability varies by state, by UI experience rates and taxable wage bases. In California, the following rates apply:Unemployment Insurance (UI)—rate varies and is imposed on first $7,000 of wagesPersonal Income Tax Withholding (PIT)—6.0% on all wages, but is generally eliminated if the company has issued Forms 1099 to the ICsSupplemental Disability Insurance (SDI)—1.0% on approximately first $95,000 of wagesImpose interest and penalties* The rate varies due to the 2011 and 2012 payroll tax holiday that reduced employee Social Security taxes from 6.2% to 4.2%_1.PPTX
141IRS Payroll Tax Audits: Example of Tax Exposure and Tax Relief The annual “full rate” tax exposure for 60 misclassified independent contractors averaging $50,000 is approximately $1,500,000.$1,167,000 for federal taxes (FITW, FICA and FUTA)$332,000 for California EDD tax liabilities (PIT, SUI, SDI, interest and penalties), but reduced to $125,000 if Forms 1099 issued to ICsRelief provisions can reduce the four year full-rate exposure of approximately $5 million as follows:One-Year Total Four-YearRelief Provision Exposure ExposureNo Relief ,167, ,668,000Statutory relief , ,281,600100% CSP Offer , ,40025% CSP Offer , ,100VCSP Offer , ,000Section 530 “Off-Code” Relief_1.PPTX
142Federal Payroll Tax Relief Significant Statutory and Administrative Payroll Tax Relief Exists:Section 530 ReliefSection 3509 ReliefClassification Settlement Program ReliefVoluntary Classification Settlement Program Relief (best settlement rates, but shifting standards)_1.PPTX
143Federal Payroll Tax Relief: Section 530 Relief Reduces the employer’s federal employment tax exposure to zero for all past and future yearsEmployer-only relief and only for employment taxesCan continue treatment of the workers as independent contractors for payroll tax purposesIRS bears burden of proofThree TestsReporting ConsistencySubstantive ConsistencyReasonable Basis (prior audit, industry practice, “judicial” precedent or any other reasonable basis)_1.PPTX
144Federal Payroll Tax Relief: Section 3509 Relief Provides an opportunity for reduced employment tax assessments if service recipient issued Forms 1099.Section 3509 does not provide any relief regarding the employer’s portion of FICA taxes nor the FUTA tax.The effective Section 3509 rate is 10.68% for both FICA and FITW for the compensation paid to reclassified worker. (Note however, that due to the 2% payroll tax holiday applicable to employee-share FICA taxes in 2011 and 2012, the Section 3509 rate for these two years was 10.28%. Also, the comparative rate is slightly higher for 2013, due to the Additional Medicare Tax applicable to employees with FICA-taxable wages in excess of $200,000.)_1.PPTX
145Federal Payroll Tax Relief: IRS CSP Relief The Classification Settlement Program (“CSP”) is available if the business previously issued Forms 1099 and agrees to prospectively reclassify the ICs as employeesOnly applies if the business is under an actual ongoing IRS auditThe business will is assessed employment tax liability as either 25% or 100% of the Section 3509 liability for the most recent year under audit (i.e., generally ranges from 0.5% to 3% of the remuneration paid to the ICs)_1.PPTX
146Federal Payroll Tax Relief: IRS VCSP Relief The Voluntary Classification Settlement Program (VCSP) seeks to encourage voluntary prospective worker reclassificationVCSP is an alternative to CSP which only extends relief to businesses actually under auditThe IRS will not conduct a payroll tax audit for workers covered by a VCSP agreement for prior years in exchange for:a taxpayer’s agreement to treat a class of workers as employees for future tax periods for payroll tax purposes, anda payment of 10% of the Section 3509 rates (i.e., 0.3% to 1% of remuneration paid to ICs)_1.PPTX
147Federal Payroll Tax Relief: IRS VCSP Relief Important CharacteristicsOptional program for an employer’s federal payroll tax reliefRequires prospective reclassification from IC to employeePay taxes equal to 1% of the IC remuneration paid during the most recent year regardless of amount at issue for all yearsNo interest or penaltiesNo relief to the workerAudit relief—IRS will not audit for worker classification for prior years_1.PPTX
148Federal Payroll Tax Relief: IRS VCSP Relief Relevant RequirementsMust prospectively reclassify independent contractors as employeesMust have consistently treated the workers as “nonemployees”Must have filed all required Forms 1099 for prior three yearsMust not currently be under any IRS audit (originally construed to mean income tax, payroll tax, etc., but then narrowed to just payroll audits).Must not currently be under any DOL or state agency audit addressing worker classification issuesIf previously under audit, must have complied with audit results_1.PPTX
149Federal Payroll Tax Relief: IRS VCSP Relief Relevant Requirements – Citations to AuthoritiesIRS Announcement , IRB 503, as superceded by Announcement , IRB 725 had allowed employers to qualify for VCSP so long as they were not under an IRS employment tax audit, and also allowed participation, provided only that the employers must have consistently treated workers as non-employees filed all required Forms 1099-MISC covering the previous three tax years.This Form 1099-MISC filing requirement was temporarily suspended in 2012 for certain employers, per Announcement , IRB 724, but that temporary relief expired on June 30, 2013.Narrower Standards after June, 2013_1.PPTX
150Methods to Reduce Exposure from an IRS Independent Contractor Audit Assess ExposureSeparately assess tax, benefits, and employment law exposureDetermine risk tolerance in each areaUndertake Section 530 IC ReviewsDo not rely solely on Common Law testApply the IRS Three-Factor Test in IRS Form SS-8Determine availability of relief under Section 530, Section 3509, CSP and VCSPDetermine the availability of any state relief provisions_1.PPTX
151Methods to Reduce Exposure from an IRS Independent Contractor Audit Keys to Reducing Independent Contractor ExposureIdentify reasonable basis for Section 530 and/or CSP ReliefAlways issue Forms 1099Obtain services from ICs who have incorporated or are provided by third partiesNeutralize employee benefits considerations by adopting “Microsoft Language”Seek consistency between federal and state treatment (but at times recognize that consistency is not possible due to relief provisions)Use well-drafted written contractsConsider using “payrolling” companies_1.PPTX
152Methods to Reduce Exposure from an IRS Independent Contractor Audit List of Do’s and Don’tsDOConduct compliance reviewsConduct internal training to raise awarenessUse incorporated independent contractorsMonitor length of relationships and hours worked, butLimit services to less than full-time,Limit services to a short-term nature, andAvoid hourly feesLimit expense reimbursements to nonroutine expensesRequire verification of tax paymentsRequire a waiver of all employee benefitsDevelop and review standardized independent contractor agreements_1.PPTX
153Methods to Reduce IRS Independent Contractor Audit Exposure DO NOTRely solely on the common law testRetain rights to direct or control the contractorImpose restrictions on the methods or means for the performance of the servicesAllow the consultant to direct/control/supervise your employeesRequire reports from or provide reviews to the contractorProvide equity compensationPay hourly fees or provide a profits guaranteeExtend privileges/benefits of a type provided to employees.Doc v.1_1.PPTX
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