TEI Chicago February 25 2014 Payroll Tax

Report
Chicago Chapter
Tax Executives Institute
February 25, 2014
Current Developments in
Compensation and Benefits
Mary (“Handy”) Hevener
[email protected]
(202) 739-5982
Andy R. Anderson
[email protected]
(312) 324-1177
Morgan, Lewis & Bockius LLP
© Morgan, Lewis & Bockius LLP
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Final Affordable Care Act Shared
Responsibility Rules
Andy R. Anderson
[email protected]
(312) 324-1177
Morgan, Lewis & Bockius LLP
© Morgan, Lewis & Bockius LLP
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Final Shared Responsibility Rules
• Released 2.10.2014
– Prior day (2.9.2014) was a key date in numerous transition
rules
– Finalizes proposed rules from late 2012
• Key concepts:
– Very similar in scope and content to proposed rules
• Retains and expands proposed transition rules
• Retains and expands full-time employee determinations
• Retains and clarifies affordability safe harbors
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Final Shared Responsibility Rules
– Confirms 2015 Shared Responsibility effective date for
large (100 or more FTE/FTeq) employers
• Expands proposed 95/5% “offer” rule to 70/30% for 2015, but
can still lead to “inadequate coverage” penalty
• The 70% expansion creates new planning opportunities
– Delays Shared Responsibility effective date until 2016 for
mid-size employers (50 to 99 FTE/FTeq)
• Numerous requirements and a necessary certification in
order to qualify
• Places new emphasis on when an employer is “small”
enough to escape Shared Responsibility rules for 2015
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Final Shared Responsibility Rules
– Lots (and lots, and lots) of small detail changes that are
grounded in comments to the proposed rules and special
interest lobbying
– Final Regulations are generally “clean” for 2016 and
beyond
• Special 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 rules
– Must, as a result, check multiple sources, particularly for 2015
specifics
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Final Shared Responsibility Rules
– Preamble nice overview of law, prior guidance, and
proposed rules
– See also new Q&As on IRS website:
• http://www.irs.gov/uac/Newsroom/Questions-and-Answerson-Employer-Shared-Responsibility-Provisions-Under-theAffordable-Care-Act
– Imbedded expectation for more “subregulatory” guidance
in a number of areas
• Such as additional FAQs, Q&As, etc.
– Next up: Reporting Rules
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Prior/Future Material
• ACA considerations for employers
– http://www.morganlewis.com/index.cfm/publicationID/8CD8F0A9
-4F6B-4170-A73A-3451008094D6/fuseaction/publication.detail
• ACA considerations for group health plans
– http://www.morganlewis.com/index.cfm/publicationID/F5C8601D
-373C-4E4A-9850-671BB3B82499/fuseaction/publication.detail
• ACA considerations for individuals
– http://www.morganlewis.com/index.cfm/publicationID/0484594361B7-49DE-BB0E-BAF9D3403D4E/fuseaction/publication.detail
• Companion LawFlash to Final Rules is in the pipeline
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Who Is Subject to the Shared Responsibility
Rules in 2015?
• Only employers with 100 or more FT/FTeq employees
– On average, at least 100 FT/FTeq employees on business
days during the previous calendar year (initially 2014)
• Six-consecutive-month transition rule for 2014
– Determine if “large” by adding together:
• FT employees
– 30 hours per week (or 130 hours per month)
• FT employee equivalents
– Total hours worked by all PT employees divided by 120
• From all controlled group employers
– Reserved for government and church employers
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Who 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 coverage
• Exempts most overseas employees
• Predecessor employers (still reserved for future guidance)
• Most employers will know, well in advance of 2015,
whether they are subject to the employer mandate
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Who Is Subject to the Shared Responsibility
Rules in 2016?
• Expanded to include employers with 50-99 FT
employees
– Applied the same as 2015 rules for larger employers
– Measured on the basis of 2014 workforce
• Must maintain size and hours of workforce for period from
2.9.2014 to 12.31.2015
• Must maintain previously offered coverage (if any) from 2.9.
2014
• Must certify compliance as part of section 6056 reporting
– Which apparently will apply to such employers for 2015
• Does not generally carryover other 2015 transition rules
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Non-Calendar Year Plans
• There are revised and new (but still limited) delayed
effective date rules for non-calendar year plans existing
(and not modified) after 12.27.2012
– Delayed until start of non-calendar year for any employee
eligible to participate 2.9.2014
– Delayed 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 2.9.2014; or
• Covered at least 1/4 of all employees on a day in 12-month
period ending 2.9.2014
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Non-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 2.9.2014; or
• Covered at least 1/3 of ACA FT employees on a day in 12month period ending 2.9.2014
– Useful for employers with a significant percentage of
employees who will not become ACA FT employees
– Also applies to 2016 delay for smaller employers
– Regardless, must do Section 6056 reporting for all of 2015
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Shared Responsibility Basics
No Coverage Penalty
Inadequate Coverage Penalty
If employer does not offer Minimum
Essential Coverage to 95% of its FT
employees
If employer offers coverage to its FT
employees, but the coverage is not
Affordable and/or does not provide
Minimum Value
AND
One FT employee enrolls in an Exchange and receives a subsidy
Employer must pay penalty of:
Employer 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)
© Morgan, Lewis & Bockius LLP
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No Coverage Penalty
• Offer
– At least 95% of all FT employees (and their children in
2016) or at least 70% for 2015
• FT employee = 30+ hours per week (130+ hours per month)
• Treasury refused to increase above 30 hours
• Children now excludes foster children and stepchildren
– Must offer coverage through end of month in which child attains
age 26
– Excludes children who are not citizens or residents of the U.S.
» But includes children resident in Canada or Mexico
– Qualifying coverage . . .
• “Minimum Essential Coverage” (basically any ER-sponsored plan)
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No 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 penalty
• Only 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 (100-133% of federal poverty level)
– Household income is more than 400% of federal poverty level
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No Coverage Penalty
– Calculated on ALL FT employees of each controlled group
member separately
• 30/80 employee reduction apportioned across controlled
group members
• Offer includes offer of coverage from:
– Multiemployer/single-employer Taft-Harley plans
• Additional interim guidance for near future
– PEOs (if client pays more for the offered coverage)
– MEWAs
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No Coverage Penalty
– Includes Evergreen offers
– Offer by one controlled group member satisfies obligation
for all members
• Useful for large single plan across the entire controlled group
– No specific rules for demonstrating an offer was made
• Limited “no offer” opportunity for coverage providing
minimum value that is free or meets Federal poverty level
affordability safe harbor
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Inadequate Coverage Penalty
• Offer
– To all FT employees (and their children in 2016)—or fail to
offer to up to 5% (up to 30% in 2015) of FT employees
• FT employee = 30+ hours per week (130+ hours per month)
• Children now excludes foster children and stepchildren
– Must offer coverage through end of month in which child attains
age 26
– Excludes children who are not citizens or residents of the U.S.
» But includes children resident in Canada or Mexico
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Inadequate Coverage Penalty
• Offer
– Qualifying coverage
• Is “Minimum Essential Coverage” and
• Provides “Minimum Value”
– That is Affordable
• Not more than 9.5% of household income for employee-only
coverage
• Safe harbors (discussed later)
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Inadequate 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 (100-133% of federal poverty level)
• Household income is more than 400% of federal poverty
level
– Applied separately to each controlled group member
• Limits scope of penalty to only part of controlled group
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Who Is a Full-Time Employee?
• Average 30 hours of service/week
– For non-hourly employees, 8 hours/day or 40 hours/week
equivalencies
– 130 hours/month can be used
• Different from large employer determination
– No need to combine PT employees into full-time
equivalents
• Determined on a controlled group basis
– Very challenging for transfers within a controlled group
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Who Is a Full-Time Employee?
• Determination of FT status
– Under statute, this is determined monthly on an ongoing
basis
• Final rules contain new details and procedures for
determining status on a monthly basis
– Plugs some of the prior holes applicable to monthly
determinations
– Very complicated new final rules for when individuals move
between different methods of determining status over their
careers
» Special phased retirement (and similar situations) rule
• Employees whose status is clearly full time when hired must
be offered coverage within 3 months of hire
© Morgan, Lewis & Bockius LLP
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Who Is a Full-Time Employee?
– Voluntary safe harbor method for new variable hour,
seasonal, and part-time employees
• Permits 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/nonunion, different entities, different states)
• Short (less than 2 months) administration period to start
coverage if use full initial measurement period
• Will be complicated to track and implement
– Note new part-time requirements!!
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Who Is a Full-Time Employee?
– Voluntary safe harbor method for ongoing employees
• Permits 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 (612 months)
• Employer can define periods, subject to consistency, based
on categories of employees (i.e., salaried/hourly, union/nonunion, different entities, different states)
• Expected to be tied to open enrollment process and timing
• 90-day administration period to start coverage
• Must transition new variable hour, seasonal, and part-time
employees to this ongoing measurement process
© Morgan, Lewis & Bockius LLP
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Who Is a Full-Time Employee?
– Special rules for:
• Seasonal employees (6 month rule)
• Volunteers
• Schools
• Adjunct faculty (new 2-1/2 hour equivalency)
• Rehired employees (now 13 consecutive weeks—still 26 for
educational organizations)
• International employees and transfers
• Temporary staffing firms
• Section 3508 employees
• Cruise ships
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Who Is a Full-Time Employee?
• U.S. territories
• Student work-study
• On call hours
• Layover hours
• Religious orders
• Home healthcare workers
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When Is Coverage Affordable?
• Necessary to avoid Inadequate Coverage penalty
• Premium for cheapest employee-only coverage must be
less than 9.5% of household income
– No cap on spouse/children premiums
• May be up to COBRA cost of coverage
• Three 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 year
• New special rules for partial years
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When 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 reduced
– Federal Poverty Line – Premium cannot exceed 9.5% of
an amount equal to the Federal poverty line for the year
divided by 12
• Can use the most recently published guidelines in effect 6
months prior to the beginning of the plan year
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Lingering Concerns
• Nondiscrimination rules
– Particularly worrisome if employer has different health
coverage across its controlled group
• ERISA section 510 claims
• ACA Whistleblower claims
• Cadillac Tax
– Some coverage may be too rich for 2018
• Is 2015/2016 the time to cut back?
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New Developments in Payroll Tax Controversies:
Traveling Employees Crossing U.S. and State
Borders, and Developments in Independent
Contractor Audits
Mary (“Handy”) Hevener
[email protected]
(202) 739-5982
Morgan, Lewis & Bockius LLP
© Morgan, Lewis & Bockius LLP
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Overview
A.
B.
C.
D.
E.
Federal Data Collection Program Audits
Payroll Audits of Expatriate and Impatriate Employees
Wage Recharacterization Audits
State Payroll Tax Audits of Traveling Employees
Developments in Independent Contractor Audits
© Morgan, Lewis & Bockius LLP
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DATA COLLECTION AND
FRINGE BENEFITS AUDITS
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Data 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 2009-2011).
• 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).
© Morgan, Lewis & Bockius LLP
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Data 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.)
© Morgan, Lewis & Bockius LLP
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New 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 04-113-009), 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.
© Morgan, Lewis & Bockius LLP
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New 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.
© Morgan, Lewis & Bockius LLP
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Data Collection and Fringe Benefit Audits
1. 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)
2. Reimbursed expenses;
–
Code § 62(c) compliance
3. Executive 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.
© Morgan, Lewis & Bockius LLP
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Data Collection and Fringe Benefit Audits
4. Payroll tax compliance (including expatriates, and NRAs
traveling to the U.S.); and
–
Focused 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 1099MISC), B-1, J, and H-1B visa issues, and payroll tax deposit
timing (with focus on options/RSUs).
5. Worker/independent contractor classification
–
Focused 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).
© Morgan, Lewis & Bockius LLP
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Data Collection and Fringe Benefit Audits
Possible State Referrals
• Not 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).
© Morgan, Lewis & Bockius LLP
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Procedural 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.
© Morgan, Lewis & Bockius LLP
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2010 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%.
© Morgan, Lewis & Bockius LLP
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2010 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.
© Morgan, Lewis & Bockius LLP
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2010 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.
© Morgan, Lewis & Bockius LLP
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2010 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.
© Morgan, Lewis & Bockius LLP
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FEDERAL PAYROLL AUDITS
OF CROSS-BORDER
EMPLOYEES: COMMON AUDIT
ISSUES
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Common Audit Issues for Cross-Border
Employees
1. Tax Return Preparation
2. Expatriate Withholding
3. Impatriate Withholding
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Common 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. § 1.1325(a)(1)(iii); Code § 212; Rev. Rul. 73-13; P.L.R.
8547003; P.L.R. 199929043; and F.S.A. 200137039 (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.
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Common 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. 92-69 (applying this principle to jobsearch 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. 63-144 (question 31); Doak v. Comm’r, 234 F.2d 704
(1956); and Teeling v. Comm’r, 42 T.C. 671 (1964), acq. 1965-2 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).
© Morgan, Lewis & Bockius LLP
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Common Audit Issues for Cross-Border Workers:
Tax Return Preparation – Employer Response
• Cost cannot be used to measure value, per Reg. § 1.6121(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.)
© Morgan, Lewis & Bockius LLP
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Common 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 preand post-assignment periods, solely benefit the employer.
© Morgan, Lewis & Bockius LLP
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Common 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. 73-13 and P.L.R.
8547003.
– Under the facts of Rev. Rul. 73-13, 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. 8547003 differs from most employers’ situations,
since few, if any, expatriate employees are ever given a
choice between the tax preparation services and cash.
© Morgan, Lewis & Bockius LLP
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Common 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.
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Common 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 § 911. See Treas. Reg.
§ 31.3401(a)(8)(A)-1(a)(1)(i).
• In many instances, the IRS agents’ computations of the
Code § 911 exclusion significantly understate the
available exclusion.
© Morgan, Lewis & Bockius LLP
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Common Audit Issues for Cross-Border Workers:
Expatriate Withholding – Employer Response
•
Qualified individuals could exclude up to $91,500 in 2010. $92,900 in 2011.
$95,100 in 2012, $97,600 in 2013, and $99,200 in 2014. See Code §
911(b)(2)(D)(i); Rev. Procs. 2009-50, 2010-40, 2011-52, 2012-42, and
2013-35.
•
The 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. § 1.911-3(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 year
The number of days in the taxable year
•
IRS agents often misapply (or ignore) this exemption.
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Common 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 § 901. See P.L.R. 8129013.
• Some IRS agents insist on detailed explanations (and translations)
or foreign laws, plus proof that withholding in fact occurred, before
applying this exclusion.
© Morgan, Lewis & Bockius LLP
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Common 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 W4 with high numbers of exemptions.
© Morgan, Lewis & Bockius LLP
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Common 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.
© Morgan, Lewis & Bockius LLP
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Common 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. § 31.3402(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.
© Morgan, Lewis & Bockius LLP
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Common 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.
© Morgan, Lewis & Bockius LLP
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Common 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; or
– Producing records evidencing the costs of preparing each
employee’s tax return and related tax equalization computations.
© Morgan, Lewis & Bockius LLP
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Best 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?
© Morgan, Lewis & Bockius LLP
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Common 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.”
© Morgan, Lewis & Bockius LLP
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Common 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.
© Morgan, Lewis & Bockius LLP
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Common 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.
© Morgan, Lewis & Bockius LLP
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Common 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 postretirement 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.”
© Morgan, Lewis & Bockius LLP
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Common 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.”
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Common 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.
© Morgan, Lewis & Bockius LLP
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Common 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.
© Morgan, Lewis & Bockius LLP
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Common 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); and
– It 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).
© Morgan, Lewis & Bockius LLP
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Common 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.
© Morgan, Lewis & Bockius LLP
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Common 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 nonAmerican employers at the point the compensation is
ultimately received.
© Morgan, Lewis & Bockius LLP
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Common 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. § 1.861-4(b)-(d).
• However, this is not the exclusive method, as source-ofincome 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.
© Morgan, Lewis & Bockius LLP
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Common 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 noncitizens 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).
© Morgan, Lewis & Bockius LLP
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Best 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?
© Morgan, Lewis & Bockius LLP
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WAGE RECHARACTERIZATION
AUDITS
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Wage 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.
© Morgan, Lewis & Bockius LLP
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Wage 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. § 1.1325(a)(1)(v).
© Morgan, Lewis & Bockius LLP
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Wage 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.
© Morgan, Lewis & Bockius LLP
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Wage Recharacterization Audits:
Choices between Cash and Code § 132(d) Benefits
• Specifically, Treas. Reg. § 1.132-5(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.
© Morgan, Lewis & Bockius LLP
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Wage 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. § 1.125-1(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.
© Morgan, Lewis & Bockius LLP
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Wage 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. § 1.1251(q).
• The scheduled effective date for these proposed regulations
was plan years beginning on or after January 1, 2009. See
Prop. Reg. § 1.125-1(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, 1265-66
(1970).
© Morgan, Lewis & Bockius LLP
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Wage 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. 9325023 (elective commission reduction to place
specified amounts in a reimbursement account not an
“accountable plan”);
– In both P.L.R. 9822044 and in an unpublished 1998 field service
advice, F.S.A. 002985, 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.
© Morgan, Lewis & Bockius LLP
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Wage Recharacterization Audits:
Choices between Cash and Code § 132(d) Benefits
• In P.L.R. 199916011, 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. 200035012 , 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.
© Morgan, Lewis & Bockius LLP
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Wage 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 2001-1 U.S.T.C.
¶50,463.
© Morgan, Lewis & Bockius LLP
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Wage 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.
© Morgan, Lewis & Bockius LLP
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Wage 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. 2012-25, providing
various examples of prohibited wage recharacterization
– most in the context of per diem travel expense
reimbursement plans.
• Three examples in Rev. Rul. 2012-25 (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 jobrelated expenses.
© Morgan, Lewis & Bockius LLP
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Wage Recharacterization Audits:
Choices between Cash and Code § 132(d) Benefits
• One example in Rev. Rul. 2012-25 allows prospective wage
reductions for all employees in a housecleaner workforce,
coupled with a reimbursement plan for workers documented
expenses.
• Rev. Rul. 2012-25 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.
© Morgan, Lewis & Bockius LLP
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Wage 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. § 1.132-5(a)(1)(i).
– The accounts should cover pre-specified types of reimbursable
business expenses—again to avoid any violation of Treas. Reg.
§ 1.132-5(a)(1)(i) (which prohibits the establishment of accounts
to pay fixed amounts of “unspecified noncash benefits”).
© Morgan, Lewis & Bockius LLP
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Wage 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.
© Morgan, Lewis & Bockius LLP
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Wage 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. § § 1.451-1 and -2; Rev. Rul. 60-31, because the
assigning employee never had any immediate or “current”
right to any specific amount.
– See Trucks, Inc. and Worldwide Labor Support (cited
above.
© Morgan, Lewis & Bockius LLP
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Wage 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”).
© Morgan, Lewis & Bockius LLP
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STATE AND LOCAL TAX
DEVELOPMENTS FOR MOBILE
WORKFORCE EMPLOYERS
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Topics Covered
I.
II.
III.
IV.
V.
Current State Rules
Mobile Workforce State Income Tax Simplification Act
Voluntary Compliance Programs
NY MTA Payroll Tax Refund Claims
Federal Protections
© Morgan, Lewis & Bockius LLP
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I.
Current State Rules: State Taxation of
Workers in Multiple States & Employer
Withholding Obligations
• Companies 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.
© Morgan, Lewis & Bockius LLP
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State Taxation of Workers in Multiple States:
Impediments/Opposition
• Form W-2 includes spaces in Boxes 15-20 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.
© Morgan, Lewis & Bockius LLP
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State 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; and
– Payments of any wages subject to income tax in the state
(or subject to contribution under the state’s unemployment
compensation laws).
© Morgan, Lewis & Bockius LLP
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State 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 NY
– GA – 23 days a quarter, or GA-allocated wages exceeding 5% of
total compensation
– CT – 14 working days a year
– ND – 20 working days a year
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Overview of Thresholds
WA
ME
MT
ND
MN
OR
WI
ID
SD
WY
MI
PA
UT
CA
IL
CO
KS
IN
OH
WV
MO
KY
AZ
OK
NM
TX
AR
SC
AL
GA
LA
HI
FL
Nonresident employees subject to tax withholding on first day of travel
Nonresident employees subject to tax withholding after reaching threshold
No general personal income tax (or, in the case of Washington, DC, no tax on nonresidents)
© Morgan, Lewis & Bockius LLP
VA
NC
TN
MS
98
VT NH
MA
CT
IA
NE
NV
AK
NY
RI
NJ
DE
MD
State 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 nonwithheld 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).
© Morgan, Lewis & Bockius LLP
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State 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.
© Morgan, Lewis & Bockius LLP
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State 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. 821018 (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.
© Morgan, Lewis & Bockius LLP
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State 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
822004 (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 822476 (2011).
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State 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 132.18(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. 820440 (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).
© Morgan, Lewis & Bockius LLP
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State 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. 2008-9044 (“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 nonresidents. (See discussion below.)
© Morgan, Lewis & Bockius LLP
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State 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 489090.
© Morgan, Lewis & Bockius LLP
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State 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 nonresidents 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.
© Morgan, Lewis & Bockius LLP
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II. 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. 1864 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, 2013. 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 [email protected]
© Morgan, Lewis & Bockius LLP
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Mobile 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 outof-state taxes
– Strong state opposition
• The 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.
© Morgan, Lewis & Bockius LLP
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Mobile 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 day
– Recordkeeping issues
– Unclear whether it simplifies anything
© Morgan, Lewis & Bockius LLP
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Mobile 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 day
– A dollar threshold should be added so that highly paid
employees might be subjected to withholding for less than 30
days of work
– Stock options and multiyear compensation should be exempted
• The House Committee on the Judiciary approved H.R. 1864
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.
© Morgan, Lewis & Bockius LLP
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MTC Model Statute
• The 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); and
– reside in states that have reciprocal exemptions or do not
impose personal income taxes.
© Morgan, Lewis & Bockius LLP
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MTC Model Statute
• Certain 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 perevent basis;
– professional entertainers;
– construction laborers; and
– key employees.
© Morgan, Lewis & Bockius LLP
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MTC Model Statute
• Under 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.
© Morgan, Lewis & Bockius LLP
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Telecommuter 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.
© Morgan, Lewis & Bockius LLP
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III. 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 relief
• New York has a streamlined program.
• California has both a voluntary compliance program and
a filing compliance agreement program.
• Other states
© Morgan, Lewis & Bockius LLP
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Voluntary 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
programs
• Typically anonymous
• Formal agreement
• Correction programs have worked for executive groups
and have eliminated the need to file individual returns.
© Morgan, Lewis & Bockius LLP
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IV. 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.
© Morgan, Lewis & Bockius LLP
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NY MTA Payroll Tax Refund Claims
• Although this ruling in Mangano, et al. v. Silver, et al., N.Y. S.
Ct., No. 14444/10, 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 http://www.tax.ny.gov/bus/mctmt/mctmt_legal proceedings.htm
and the claim form, at https://www8.tax.ny.gov/MCPC/mcpcStart
Some employers estimate that their refunds could exceed $1 million.
© Morgan, Lewis & Bockius LLP
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V. Federal Protections: Federal Blocker of
State Taxation of Certain Retirement Income
of Former State Residents
• Since 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.
© Morgan, Lewis & Bockius LLP
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Federal 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.
© Morgan, Lewis & Bockius LLP
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Federal 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.
© Morgan, Lewis & Bockius LLP
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Federal 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; and
– Certain 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.
© Morgan, Lewis & Bockius LLP
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Federal 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.
© Morgan, Lewis & Bockius LLP
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Federal 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.
© Morgan, Lewis & Bockius LLP
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Federal 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.
© Morgan, Lewis & Bockius LLP
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Federal 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.).
© Morgan, Lewis & Bockius LLP
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Federal 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.
© Morgan, Lewis & Bockius LLP
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Federal 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).
© Morgan, Lewis & Bockius LLP
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Additional 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 § 40116 (Anti-Head Tax Act);
– Motor Carriers – 49 USC §14503;
– Fishing vessels, or vessels engaged in “foreign, coastwise,
intercoastal, interstate, or noncontiguous trade” – 49 USC
§ 11108.
© Morgan, Lewis & Bockius LLP
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IRS 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 Provisions
• Best Practices and Methods to Reduce Exposure
• IRS Information Sharing with the DOL and the states
(including particularly California)
© Morgan, Lewis & Bockius LLP
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IRS 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); and
• backup withholding audits (involving both alleged
underwithholding, and penalties for non-filing of Information
returns).
© Morgan, Lewis & Bockius LLP
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IRS 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).
© Morgan, Lewis & Bockius LLP
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Employee or Independent Contractor?
•
Common Law Employee
•
Independent Contractor
•
Leased Employees
•
Joint Employment/Co-Employment
•
Dual-Status Workers
•
Corporate Officers and Other “Statutory Employees”
•
“Statutory Nonemployees”
•
Section 218 Agreement Employees
© Morgan, Lewis & Bockius LLP
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Employee Misclassification:
Government Stakeholders
Federal and State Agencies Affected by Employee Misclassification
Agency
Areas potentially affected by employee misclassification
IRS
•
Federal income and employment (payroll) taxes
DOL
•
•
•
•
Minimum wage, overtime, and child labor provisions
Job protection and unpaid leave
Safety and health protections
Immigration/Form I-9 issues
IRS, DOL and PBGC
•
Pension, health, and other employee benefit plans
Department of Health and Human Services
•
Medicare benefit payments
EEOC
•
Prohibitions of employment discrimination based on
factors such as race, gender, disability, or age
NLRB
•
The right to organize and bargain collectively
SSA
•
Retirement and disability coverage and payments
State Agencies
•
•
•
Unemployment insurance benefit payments
State income and employment taxes
Workers’ compensation benefit payments
© Morgan, Lewis & Bockius LLP
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Employee or Independent Contractor:
The Common Law Test
20-Factor Test
•
instructions
•
order or sequences set
•
integration
•
reports
•
payments
•
expenses
•
training
•
investment
•
services rendered personally
•
tools and materials
•
hiring assistants
•
profit or loss
•
continuing relationship
•
works for more than one person or firm
•
set hours of work
•
offers services to general public
•
full-time work
•
right to discharge
•
work done on premises
•
right to quit
© Morgan, Lewis & Bockius LLP
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Independent 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 Factors
– Financial Control Factors
– Relationship of the Parties Factors
• IRS Three-Factor Test considers the work that is being
performed and the business context in which it is being
performed
© Morgan, Lewis & Bockius LLP
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Why Does It Matter?
Benefits and Business Expenses
Differences Among Benefits Responsibilities
Type of Benefits
Employees
Independent Contractors
Retirement plans
Employers
sponsor benefit
plans
Employers and
employees
contribute
Contractors sponsor
plans
Contractors bear the
full financial cost of
the plans
Healthcare
Employers
sponsor on a taxfree basis
Employers and
employees
contribute
Contractors obtain
coverage
Contractors bear the
full financial cost, but
receive a tax
deduction
Reimbursed expenses/
accountable plans
Employers can
reimburse
expenses
Nontaxable to the
extent they are paid
under an
accountable plan
Service recipient can
reimburse, although
expenses are
generally
unreimbursed
Reimbursed
expenses are
nontaxable if they are
under an accountable
plan
Unreimbursed expenses
Many employers
don’t fully
reimburse
expenses
Unreimbursed
expenses are
subject to a 2% floor
and AMT
Businesses don’t
generally reimburse
expenses
Not subject to a 2%
floor or AMT
© Morgan, Lewis & Bockius LLP
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Why Does It Matter?
Payroll Taxes
Differences Among General Tax Responsibilities
Employees
Independent Contractors
Businesses'
general
responsibilities
Workers' general
responsibilities
Federal income Tax
Withholding (FITW)
Withhold tax from
employees' pay
Pay full amounts
owed, generally
through withholding
Generally, none
Pay full amounts
owed, generally
through estimated tax
payments
Social Security and
Medicare Taxes (FICA)
Withhold one-half
of taxes from
employees' pay
and pay other half
Pay half of total
amounts owed,
generally through
withholding
None
Pay full amounts
owed, generally
through estimated tax
payments
Federal Unemployment
Taxes (FUTA)
Pay full amount
None
None
None
State Unemployment
Taxes (SUTA/SUI)
Pay full amount,
except in certain
states
None, except pay
partial amount in
certain states
None
None
Type of Tax
© Morgan, Lewis & Bockius LLP
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Businesses' general
responsibilities
Workers' general
responsibilities
Why Does It Matter?
Payroll Taxes and the Tax Gap
(Billions)
$240
150 - 187
$200
$160
$120
66 - 71
$80
30
$40
4
$0
Individual
Employment
Corporation
Estate & Excise
$5 billion associated with FICA/FUTA
$51 billion-$56 billion associated with SECA
Other 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.
© Morgan, Lewis & Bockius LLP
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Why Does It Matter?
Payroll Taxes
• Full-rate Federal statutory liability equal to at least 40% of
compensation payments to independent contractors
–
25% FITW exposure
–
15.3% Employer and Employee FICA (Social Security and Medicare)*
–
Social Security Taxable Wage Base ($110,100 for 2012)
–
Interest-free adjustments and rarely impose penalties
• Full-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 wages
–
Personal Income Tax Withholding (PIT)—6.0% on all wages, but is generally eliminated if the
company has issued Forms 1099 to the ICs
–
Supplemental Disability Insurance (SDI)—1.0% on approximately first $95,000 of wages
–
Impose 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%
© Morgan, Lewis & Bockius LLP
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IRS 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 ICs
Relief provisions can reduce the four year full-rate exposure of
approximately $5 million as follows:
One-Year
Relief Provision
Exposure
No Relief
1,167,000
Statutory relief
320,400
100% CSP Offer
320,400
25% CSP Offer
80,100
VCSP Offer
32,000
Section 530 “Off-Code” Relief
0
© Morgan, Lewis & Bockius LLP
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Total Four-Year
Exposure
4,668,000
1,281,600
320,400
80,100
32,000
0
Federal Payroll Tax Relief
Significant Statutory and Administrative Payroll Tax Relief
Exists:
1. Section 530 Relief
2. Section 3509 Relief
3. Classification Settlement Program Relief
4. Voluntary Classification Settlement Program Relief (best
settlement rates, but shifting standards)
© Morgan, Lewis & Bockius LLP
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Federal Payroll Tax Relief:
Section 530 Relief
• Reduces the employer’s federal employment tax exposure to
zero for all past and future years
• Employer-only relief and only for employment taxes
• Can continue treatment of the workers as independent
contractors for payroll tax purposes
• IRS bears burden of proof
• Three Tests
– Reporting Consistency
– Substantive Consistency
– Reasonable Basis (prior audit, industry practice, “judicial” precedent or
any other reasonable basis)
© Morgan, Lewis & Bockius LLP
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Federal 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.)
© Morgan, Lewis & Bockius LLP
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Federal 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 employees
• Only applies if the business is under an actual ongoing IRS
audit
• The 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)
© Morgan, Lewis & Bockius LLP
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Federal Payroll Tax Relief:
IRS VCSP Relief
• The Voluntary Classification Settlement Program (VCSP) seeks
to encourage voluntary prospective worker reclassification
• VCSP is an alternative to CSP which only extends relief to
businesses actually under audit
• The 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, and
– a payment of 10% of the Section 3509 rates (i.e., 0.3% to 1% of
remuneration paid to ICs)
© Morgan, Lewis & Bockius LLP
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Federal Payroll Tax Relief:
IRS VCSP Relief
Important Characteristics
• Optional program for an employer’s federal payroll tax relief
• Requires prospective reclassification from IC to employee
• Pay taxes equal to only @ 1% of the IC remuneration paid
during the most recent year regardless of amount at issue for
all years
• No interest or penalties
• No relief to the worker
• Audit relief—IRS will not audit for worker classification for
prior years
© Morgan, Lewis & Bockius LLP
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Federal Payroll Tax Relief:
IRS VCSP Relief
Relevant Requirements
• Must prospectively reclassify independent contractors as
employees
• Must have consistently treated the workers as
“nonemployees”
• Must have filed all required Forms 1099 for prior three years
• Must 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 issues
• If previously under audit, must have complied with audit
results
© Morgan, Lewis & Bockius LLP
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Federal Payroll Tax Relief:
IRS VCSP Relief
Relevant Requirements – Citations to Authorities
• IRS Announcement 2011-64, 2011-41 IRB 503, as superceded by
Announcement 2012-45, 2012-51 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 nonemployees 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 2012-46, 2012-51
IRB 724, but that temporary relief expired on June 30, 2013.
Narrower Standards after June, 2013
© Morgan, Lewis & Bockius LLP
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Methods to Reduce Exposure from an
IRS Independent Contractor Audit
Assess Exposure
•
Separately assess tax, benefits, and employment law
exposure
•
Determine risk tolerance in each area
Undertake Section 530 IC Reviews
•
•
•
•
Do not rely solely on Common Law test
Apply the IRS Three-Factor Test in IRS Form SS-8
Determine availability of relief under Section 530,
Section 3509, CSP and VCSP
Determine the availability of any state relief provisions
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Methods to Reduce Exposure from an
IRS Independent Contractor Audit
Keys to Reducing Independent Contractor Exposure
•
Identify reasonable basis for Section 530 and/or CSP Relief
•
Always issue Forms 1099
•
Obtain services from ICs who have incorporated or are
provided by third parties
•
Neutralize 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 contracts
•
Consider using “payrolling” companies
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Methods to Reduce Exposure from an IRS
Independent Contractor Audit
List of Do’s and Don’ts
DO
• Conduct compliance reviews
• Conduct internal training to raise awareness
• Use incorporated independent contractors
• Monitor length of relationships and hours worked, but
•
•
•
•
•
•
•
Limit services to less than full-time,
Limit services to a short-term nature, and
Avoid hourly fees
Limit expense reimbursements to nonroutine expenses
Require verification of tax payments
Require a waiver of all employee benefits
Develop and review standardized independent contractor
agreements
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Methods to Reduce IRS Independent
Contractor Audit Exposure
DO NOT
•
•
•
•
•
•
•
•
Rely solely on the common law test
Retain rights to direct or control the contractor
Impose restrictions on the methods or means for the performance
of the services
Allow the consultant to direct/control/supervise your employees
Require reports from or provide reviews to the contractor
Provide equity compensation
Pay hourly fees or provide a profits guarantee
Extend privileges/benefits of a type provided to employees.
Doc. 77904150 v.1
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DISCLAIMER
•
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legal advice on any specific matter, nor does it create an attorney-client relationship.
You should not act or refrain from acting on the basis of this information. This
material may be considered Attorney Advertising in some states. Any prior results
discussed in the material do not guarantee similar outcomes. Links provided from
outside sources are subject to expiration or change.
© 2014 Morgan, Lewis & Bockius LLP. All Rights Reserved.
•
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To ensure compliance with requirements imposed by the IRS, we inform you that any
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is not intended or written to be used, and cannot be used, for the purpose of (i)
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