From State and Local Tax

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10 Signs Your Company Is At Risk Of A State Or Local Withholding Audit

Is your company at risk of a payroll withholding audit?

Budget deficits have lead to a steady rise in state and local corporate audits over the past five years. Regulatory authorities are increasingly turning their attention to nonresident workers and the companies that employ them. In the words of Brian Gordon, a thirty-year veteran of the New York State Department of Finance and Taxation, “Politically, who better to go after than those who do not even claim to be residents of the state?”

Unsurprisingly, a KPMG survey found that nonresident state withholding is either a major or growing issue for the majority of companies surveyed. Tax departments face the challenge of trying to understand whether their company has exposures, with limited visibility and a lack of data. Below are 10 potential indicators that your company may have multi-jurisdiction tax exposures.

10 Signs Your Company Is At Risk Of A Withholding Audit:

  1. Your travel and expense records show that you have employees making frequent trips to other jurisdictions.
  2. Your company headquarters are located in a state or locality that regularly conducts withholding audits.
  3. Your company’s public presence (such as press releases, event announcements, or public filings) reveals that your senior executives are traveling on behalf of the business to a particular state.
  4. You are paying sales and use taxes, but not income tax withholding, to a state or locality.
  5. Your company has employees traveling to a state or locality that is actively conducting withholding tax audits.
  6. One of your company’s clients is undergoing a state or local audit.
  7. Your company’s vehicles are often seen in a state or locality (for example, New York City has been known to use parking tickets to identify audit targets).
  8. Your company owns property that employees use within a state or locality.
  9. A parent company operates a subsidiary in one or more states (other than the state of the parent company).
  10. Your AP records show travel and other costs paid on behalf of employees to states where they do not reside.
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Moving Your Corporate HQ? Here’s Why You Might Want to Avoid Washington and Texas

Data in a recent study highlights the stark divergence in effective tax rates for new and mature companies across states. New companies choosing a location for their headquarters may want to steer clear of Washington and Texas, where mature companies have a significant tax advantage.

Recently, the Tax Foundation and KPMG published a report on how the tax burden varies for different company types across the 50 states and Washington, D.C. We delved into the report’s data to discover which states might be the most attractive destinations for company headquarters.

It’s hardly surprising that New York has the highest effective tax rate on corporate headquarters, while Wyoming and Nebraska have the lowest burdens for new and mature companies, respectively. However, the gaps between the tax levels for new and mature companies in each state were striking.

In the majority of states, mature companies have the advantage with lower effective tax rates. Washington and Texas tie for having the largest gap favoring mature companies, 6.5%.

However, 18 states provide new companies with attractive incentives and effective tax rates lower than those for mature companies. In fact, the effective rate for a mature company with its corporate headquarters in New Jersey is more than six times higher than that for a new company.

Alabama and Iowa provide the most equitable tax environments, with less than 0.5 percentage points separating the effective tax rates for new and mature companies in each state.

A number of variables should be considered when calculating the effective tax burden. Often, the statutory tax rate is just the starting point. A company must also consider incentives, apportionment, throwback rules and several other factors that all can impact the effective tax burden. A state may appear to have a low tax rate, yet still be the most costly location for a company to place its headquarters. And, of course, many companies will still need to pay taxes to other states because of nexus or sales tax.

The report comes at time when several high-profile companies, most notably GE, are considering moving their headquarters to states with more favorable tax laws. GE has said that it will make a final decision regarding the move by the end of the year.

The table below highlights the effective tax rates (and differences) for each of the states and Washington, D.C.

Effective Tax Rates on Corporate Headquarters by State

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What Gene Bicknell’s Battle With Kansas Says About State Residency Laws

 

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It is not unheard of for tax disputes to stretch longer than a decade, especially when millions are at stake. It looks like this may be the case for Gene Bicknell and the state of Kansas.

The saga of the tax dispute between Bicknell, the man who made millions from Pizza Hut franchises, and the Kansas Department of Revenue continues with the recent decision from the Kansas Court of Appeals.

The value concerned isn’t negligible: $42 million paid by Bicknell to Kansas in 2013. If Kansas has to return the money, it could push the state budget into the red, says the Associated Press. Whether Kansas gets to keep the $42 million boils down to whether Bicknell was a resident of Kansas or Florida during 2005 and 2006.

In 2005, Bicknell changed his residency from Kansas to Florida. The following year he sold his interest in NPC International to Merrill Lynch Global Private Equity. At the time of the sale NPC International was the largest Pizza Hut franchisee in the United States. As a resident of Florida, which doesn’t have a state income tax, Bicknell sidestepped the expensive state taxes that would have resulted from selling his stake in NPC International.

As Bloomberg BNA’s Genie Nguyen has pointed out, moving to a state with no state income tax is a well-known strategy for avoiding state income taxes. However, establishing residency in a new state isn’t always that simple. In most states, including Kansas, residency is determined by an individual’s domicile. An individual can only have one domicile and where it is depends on a wide variety of factors including, but not limited to, physical presence.

Part of the legal tangle is due to the changes made after 2005 regarding how the Kansas Department of Revenue defined domicile. In 2005, as Peter J. Reilly highlights in Forbes, the DOR’s brief regulation on domicile implies that it is simply a matter of the location of an individual’s driver’s license, voter registration, and vehicle registration.

New regulations after 2005 added on a slew of other factors to consider, including:

  • how much time the individual physically spent in Kansas
  • how much time the individual physically spent in other jurisdictions
  • the individual’s previous domicile
  • property ownership
  • the physical location of the individual’s vehicle
  • where the individual receives physical mail
  • other facts “relevant to the determination of that person’s domicile”

 

In 2010, the Kansas Department of Revenue used the updated regulations to assess Bicknell with more than $42 million from the sale of his interest in NPC International in 2006. Bicknell’s roots in Kansas went deep (he was even a former candidate for governor) and consideration of the new criteria might well have questioned his Florida residency. Bicknell appealed, but three years later the Kansas Court of Tax Appeals (COTA) ruled in favor of the Department of Revenue.

Bicknell paid the $42 million but appealed once again, arguing that COTA disregarded several of the Department of Revenue’s regulations regarding residency status, as well as that those standards were “unconstitutionally vague.” This time, Bicknell may have a more favorable result. In September of 2015, the Kansas Court of Appeals vacated the previous COTA ruling. COTA will now have to reconsider the case.

The Court of Appeals declined to address Bicknell’s constitutional appeal. Whether or not the vague nature of Kansas Department of Revenue’s standards for residency is unconstitutional, it is undeniable that the lack of clarity leads to confusion and expensive court costs. Residency standards vary from state to state and are constantly changing. As Bicknell’s example shows, being caught on the wrong side of those changes can be a costly mistake.

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Experts Highlight Challenges of Business Traveler Tax Compliance

Business travel is a growing concern for companies, according to experts from Bloomberg BNA, Ernst & Young, and the Minnesota Department of Revenue. A 90-minute webcast covered pressing issues including nonresident income taxes, payroll compliance and audit defense. Below are highlights from the discussion.

Nonresident Tax Enforcement Rising Steadily

It’s estimated that U.S. business travelers will take 492.1 million trips in 2015, up 1.7% from the previous year. At the same time, state audit rates are rising steadily and business travelers are in the crosshairs.

Which states have the most to gain from pursuing nonresident income taxes? EY’s Kristie Lowery stated there are three major factors:

  1. If a state has a high volume of nonresident visitors
  2. If the business traveler doesn’t pay income tax in her resident location
  3. If the nonresident income tax rate is greater than the resident tax rate (this is most likely in states with very high personal income tax rates)

“The question is no longer if employers should comply with nonresident income tax, but how,” said Lowery.

Understanding Nexus for Resident Income Tax Withholding

What triggers nexus?

Nexus is typically triggered when a company conducts business or has some type of business connection to a location.

Are there general guidelines to what constitutes nexus for income tax withholding purposes?

In general, employee work presence in a state is taken into consideration. However, state and local laws vary in how they define what constitutes nexus. In addition, other factors can affect nexus for other business taxes, such as franchise and corporate taxes.

What is the Business Activity Tax Simplification Act (H.R. 2584)?

The Business Activity Tax Simplification Act is a bill that would prohibit states from imposing corporate and/or gross receipts taxes to companies with physical presence in a state for fewer than 15 days. The act was recently cleared by the House Judiciary Committee for a full House vote.

What is courtesy income tax withholding?

Employers may withhold resident income tax for the employees’ convenience, even if there isn’t nexus. However, it’s important to be aware that special registration may be necessary to avoid incorrect assessments of other business taxes.

Payroll Tax Pitfalls

Important payroll tax variables include whether the employer, employee, and wages are covered.

Employers – Some types of employers and industries may be exempt from nonresident income tax requirements. Non-profit organizations and government employers are exempt from FUTA.

Employees and employment – Variables that affect whether withholding and employment tax apply include the type of employment, employee-specific exemptions, time worked in the location, and worker classification.

Wages – Every jurisdiction maintains its own definition of covered wages. Some common exclusions include health or welfare benefits and qualified retirement plan contributions. However, these exclusions don’t always apply, depending on the jurisdiction and tax type.

Putting a Process in Place

When putting in place a policy, change management and communication are crucial. Employees need to understand why a new process is being put in place and how it may affect them. Tim Dalton from Ernst & Young stated that companies can perform a one-minute tax risk assessment, ranking their risk from high to low on each of the five phases of mobile workforce income tax compliance: policy design, trip tracking, tax research, tax onboarding, and withholding and reporting.

“Communication and consensus among stakeholders and coordination with service providers are key to designing and maintaining an effective system for managing your mobile workforce,” said Dalton.