In today’s business environment expansion across state lines has become commonplace. Increased corporate tax compliance and sales tax collection are clearly recognized. Conversely with a multi-state presence withholding tax becomes an overlooked state tax obligation.
Becoming compliant in multi-state withholding obligations is something that both employers and their third-party providers need to proactively manage. This starts with an understanding of what constitutes a multi-state presence, what “type” of remote employees the business hires, and a look at the withholding tax obligations for each of the states where the business finds itself in.
This article will provide a brief overview of nonresident withholding, with an emphasis on the construction industry and how nonresident withholding impacts contractors performing work across state lines.
A Brief Overview
Multi-state withholding is often an overlooked issue, but it is one that states have been taking a proactive approach in curbing noncompliance. Noncompliance has two sides; the personal income tax side of the employee and the withholding tax side of the employer. With more and more businesses sending employees across state lines to perform work, a tax responsibility has been created for both the employer and the employee, one that states are seeking to enforce.
Typically, lack of compliance in non-resident withholding stems from a lack of understanding of the employer’s responsibilities, and/or a lack of organizational controls able to isolate these issues as they arise. Many states now target nonresident withholding which can cause a financial strain on businesses not in compliance. A multi-state worker presence can be a complex issue on the employer side, as some states require that the employer withhold personal income tax in every state where the employee works. In some cases, the time worked in a particular state can be as short as one day.
Employer Withholding for Non-Resident Employees
One of the biggest challenges with getting compliant across multiple states is the vast array of rules that each of the states determines is the standard for when employers are obligated to withhold. These standards can be based on the days an employee is in a state, with the number of days ranging from a single day to 30 or more.
For instance, in Connecticut there is no requirement that an employer withhold state taxes from the wages of a nonresident employee who is working in the state of Connecticut for less than 14 days a calendar year. Contrast that with Pennsylvania who requires that every employer who pays nonresidents or residents for work performed in the Commonwealth must have taxes withheld even if that work is performed in Pennsylvania for just one day. Utah has a particularly interesting threshold, their threshold requires that the employer, not the employee, has a presence in the State. With presence in Utah being defined as doing business in the State for more than 60 days in a calendar year before that employee is required to withhold.
While it can seem daunting that some states require withholding at the first instance of the employee performing work in the state, there are states that are quite taxpayer friendly. Illinois, Arizona and Hawaii all have thresholds at or beyond the 30-day mark before an employer is required to withhold. Additionally, some states have reciprocal agreements with neighboring states allowing the residents to be taxed only by their home state.
Employer Withholding and the Construction Industry
Those in the construction industry may routinely and systematically use Independent Contractors (‘IC’s”) for their remote jobs verses sending their own employees to work in another state, or in many cases use a combination of the two. While the use of IC’s can, in many instances, alleviate employer withholding requirements there are other elements to consider.
The first is whether those IC’s have been properly classified both for federal and state tax purposes. The IRS, along with each state have standards set for deciding as to when an IC crosses over and becomes an employee. Even though historically an employer has referred to a worker as an IC does not mean that they don’t meet the standards set by the state to be considered an employee. Take California for instance, who recently passed AB5 which amended California’s labor code simplifying and streamlining the test for deciding between an IC and an employee. Under this new determination in California many construction subcontractors and other IC’s would be considered “employees” and thus require the employer to withhold for income tax purposes. California in AB5 specifically provided a crucial exception for certain individuals performing work pursuant to a subcontract in the construction industry provided a number of elements are met; such as the contract being in writing, and the subcontractor being licensed by the Contractors State License Board and the work is within the scope of that license.
California is not the only state taking on this issue, and the construction industry should have a heightened awareness regarding these changes and apply each states relevant test to each IC relationship to ensure that under state law they have not inadvertently hired a nonresident employee.
Another element of consideration, beyond the growing concerns of worker classification, is the monetary thresholds certain states have in place that would require employers to withhold tax on all payments to nonresident independent contractors. While these types of provisions are unique, they are heavily enforced. California and Pennsylvania both have provisions to this effect, with Pennsylvania’s being the most recent.
Pennsylvania requires that any non-wage payment made to a non-resident worker in excess of $5,000 during the calendar year (this is cumulative for all payments made to that worker in the relevant calendar year) must have Pennsylvania withholding at a rate of 3.07%. Pennsylvania has specific carve outs for payments made to certain entities or payments in connection with real estate.
However, for those out of state construction contractor businesses who have job sites in Pennsylvania this rule requires that any job that is performed by an out of state company, in Pennsylvania, by non-resident IC’s, in amounts in excess of $5,000, that contractor would be required to withhold Pennsylvania income tax from that IC’s payment. While some states have rules like Pennsylvania, many others have withholding requirements only for specific types of IC’s. Understanding all of the various state rules and applying them can be a heavy administrative burden for any business.
For those in construction, crossing state lines is a routine occurrence, and maintaining a proper record of the employees and IC’s performing work in multiple states can be laborious. The administrative costs of ensuring complete compliance with nonresident withholding can be extremely high and deter taxpayers from seeking out solutions. There are many considerations both at the federal and state level that all employers, but especially those in construction should be mindful of. Please reach out to your HBK Advisor to discuss how this could impact your business.