Nonresident Withholding 'Nightmare'

In a prior life, I worked in a tax department where we managed the filing of multistate income tax returns and the flood of notices received for over 500 pass-through entities. The group of entities included multi-tiered partnerships, limited liability companies with single-member limited liability companies and S corporations with Q-subs. Consequently, nonresident withholding was a major issue for us and the state tax departments with which returns were filed.

If you or your client operates within a pass-through entity such as a S corporation, partnership or limited liability company, then you know what nonresident withholding is.

In basic terms, nonresident withholding is when a state requires a pass-through entity to withhold state income tax (or make a state tax payment) on a nonresident shareholder's pro rata share of the pass-through entity's income sourced to the specific state. In other words, it is a mechanism for states to better ensure that state tax will be paid by nonresident shareholders.

Now, if you or your client operates within a multi-tiered structure of pass-through entities, then nonresident withholding can become a compliance nightmare for both you and state taxing authorities. Most states have difficulty tracking nonresident withholding when it passes through multiple layers before it gets to the ultimate taxpayer. Therefore, state tax notices upon state tax notices can become an unwelcome, but familiar friend.

With that said, here are a few tips or questions to ask when dealing with nonresident withholding in multi-tiered structures:

1. Does the state require quarterly nonresident withholding on actual payments/distributions or on allocated income? To put it simply, some states only require quarterly nonresident withholding if a cash payment is actually made to a shareholder. If states don't require quarterly nonresident withholding, most, if not all states require annual nonresident withholding on "allocated income" whether a distribution is actually paid or not.
2. Is nonresident withholding required to be done for all nonresident shareholders regardless of the type of shareholder? Meaning, is withholding required for C corp, S corp, partnership, LLCs, individual and/or trust shareholders?
3. Does the state allow or have a mechanism for nonresident shareholders to obtain a waiver or exemption from nonresident withholding? Meaning, can a nonresident shareholder provide the pass-through entity or the state with a document to keep the pass-through entity from withholding on its share of the state's source income?
4. Is the nonresident withholding required to be done on a quarterly basis? Or can it be paid one time a year?
5. In a multi-tiered pass-through entity structure, at what level is nonresident withholding required to be done? Meaning, is the lowest entity required to do the withholding or does the state only require the entity before the ultimate taxpayer to do the withholding? This is a key question, because if it is done at the wrong level, it can cause great confusion and an explosion of notices between the state and the taxpayer.

Some of the top problem states when dealing with nonresident withholding are: California, Colorado, Indiana, and Iowa. Kansas used to be a pain, but withholding is no longer required after July 1, 2014.  These are just a few. As I stated earlier, in a multi-tiered structure, nonresident withholding is a tracking 'nightmare' for both the taxpayer and the state. Obviously, it requires meticulous record keeping to get it right.

The 'Most Significant State Tax Policy Issues'

David Brunori will be in Las Vegas this week speaking at the Council On State Taxation annual meeting (Friday morning) with Doug Lindholm, Helen Hecht, and Richard Pomp. They are leading a debate/discussion on the most significant issues in state tax policy. I can't be there, but thought I would give my two cents. 

I think some of the most significant state tax policy issues are:

• the imposition of sales tax collection obligations on remote retailers;
• expanding the sales tax base to services;
• whether states should ramp-up transfer pricing training/positions or join the MTC ALAS program;
• whether states should adopt tax haven legislation which allows them to cherry-pick the taxation of foreign income or simply adopt mandatory worldwide combined reporting;
• whether states should continue to enact unconstitutional legislation forcing taxpayers to go to court;
• whether states should continue to enact retroactive legislation;
• whether states should continue to enact legislation that benefits in-state taxpayers vs. out-of-state taxpayers (i.e., market-based sourcing, single-sales factor apportionment, credits and incentives).

What do you think are the most significant issues in state tax policy?

STATE TAX PRACTICES: WHAT PEOPLE THINK BUT DO NOT SAY

(Note: I wrote this blog post originally in 2014, but unfortunately, it still applies today. It has also been one of my most popular posts.)

Did you ever see the movie, "Jerry Maguire"? In the beginning of the movie, Tom Cruise (as Jerry Maguire) has a breakdown or "break-through" as he called it. He had been working for a large sports agent firm and had grown tired of the profession, the way he treated clients, the focus on money, etc. Hence, he woke up in the middle of the night and wrote a several page "mission statement." The mission statement described how the firm should change everything - how it should change its focus from solely making money and treat clients like people, develop true relationships and actually care. 

The mission statement was called, "What People Think, But Do Not Say."

I have worked in the state tax profession for 20+ years and most of that time I have been a state and local tax consultant. I worked in industry at some large Fortune 500 companies and several accounting firms (large and small). Based on my experience and from talking to my SALT colleagues at other firms, some disturbing trends exist in our profession:

1. SALT consultants tend to move from firm to firm at a high rate, with the average length of time at one firm being 2 years.
2. Accounting firms that hire SALT consultants to build SALT practices don't always know what that actually means; they don't know what it actually looks like for their size firm (or office) and target market.  They just know they want to build one.
3. SALT consultants often struggle in getting the tax and audit folks to invite them to client meetings and pull them into projects earlier rather than later.
4. Most tax and audit folks are often used to doing things themselves - hence, their first inclination is to use SALT consultants on an as needed basis or as a "help-desk." I get it. I am a "do it yourself" kind of guy as well. Often times, it is a cost/benefit or materiality issue. I understand.
5. SALT consultants struggle with their billable time getting written off by tax or audit partners because SALT consultants are often not in control of the billing process on engagements which were obtained or started by non-SALT folks.
6. Most firms recognize SALT is a growing area and need/want a SALT resource to grow their firm; however, most firms may not be able to support or sustain a full-time SALT group.

The trends listed above do not apply to every firm. Some SALT consultants have had long careers at one firm. This is especially common in larger firms. The trends described are just a product of reality - or economic pressures on the firm or the partners themselves. Everyone is just trying to meet their goals in the best way they can. With that said, it is also a fact that so many SALT practices suffer from these trends. Hence, the question is - is there a cure? 

You have probably heard the saying - "don't keep doing the same things and expect a different result."  Well, I very much agree with that statement in this area.  I am passionate about changing these trends - in helping SALT consultants get off of the "merry-go-round." 

These trends can be overcome by building strong relationships with partners, positioning the SALT practice effectively within the firm and/or office, marketing the SALT practice effectively in the marketplace and focusing on your highest and best use - the actions that will produce the most effective results. 

Another solution for firms would be to outsource their SALT function - this would allow the firm to have access to SALT resources they need, when they need it, without having to invest a great deal upfront or year after year.

What do you think?  Have you suffered from these trends?  What solutions can you think of?

CONNECT AND BUILD COMMUNITY

Join with me in building a state tax community that builds real relationships and works together to help each other resolve complex state tax problems, influence state tax policy and further our careers and profession. 

Be a Control FREAK! and Are You Attending the Paul J. Hartman SALT Forum THIS MONTH?

I am a control freak. I hate problems, but what I hate even more - are problems that could have been avoided or problems caused by unintended consequences. Life is uncertain. Thus, it is important for us to embrace uncertainty if we are going to be happy on a daily basis. We must learn to let go. However, in regards to state taxes, embracing uncertainty can cause unintended consequences and problems that could have been avoided. Consequently, we need to be a control freak when it comes to state taxes. We must use our power for good.

If you are going to the Paul J. Hartman State and Local Tax Forum in Nashville on October 25-27, 2016, please comment or e-mail me at strahle@leveragesalt.com. I would love to meet you and talk shop.

TEI Says Retroactive Legislation Disrupts Taxpayer Expectations

On September 20, 2016, Tax Executives Institute, Inc. (TEI) issued a new policy statement on retroactive tax legislation. The policy statement takes the position that sound tax policy and administration require governments to provide taxpayers with certainty and fairness, and these principles are not satisfied when legislatures are permitted to enact retroactive tax legislation without meaningful limits.

In TEI's statement it asserts that allowing retroactive legislation to overrule a judicial decision "disrupts taxpayer expectations." I agree. As I have stated before in several blog posts, retroactive legislation creates unnecessary uncertainty, and unintended consequences. States have an obligation to create a stable and reasonable compliance environment that doesn't keep taxpayers guessing.

Multistate Voluntary Disclosure Program?

Are you aware that a taxpayer with potential tax liability in multiple states could negotiate a settlement using a uniform procedure coordinated through the National Nexus Program of the Multistate Tax Commission (MTC)?

According to the MTC, this service is to encourage taxpayers to start filing and paying taxes in states where taxpayers have substantial nexus. The MTC believes this process is faster, more efficient, and less costly for taxpayers who have potential tax exposure in more than one state. There is no charge for participation in the program.

The program generally allows taxpayers to file a voluntary disclosure agreement for tax types such as sales/use tax, and income/franchise tax (including the Hawaii GET and Washington B&O tax). 

Prior contact between a state and the taxpayer for a specific tax type disqualifies the taxpayer from participation in the program for that tax type. "Contact" includes filing a tax return, paying tax, or receiving an inquiry from the state regarding the tax type. 

Once a taxpayer enters the program, the taxpayer is required to file returns, pay the tax due, and register with the state. In return, the state waives penalties for the duration of the look-back period. Interest is still due on unpaid tax obligations during the look-back period, unless waived by the state.

The look-back period includes the number of prior tax years, and the incomplete current tax year for which taxes and interest will be due and paid under the agreement. The look-back period is determined by the state and specified in the agreement. The look-back period is generally three or four years.

The MTC claims that it keeps the identity of the taxpayer confidential during the process. The MTC only discloses the taxpayer's identity to a state after the taxpayer has entered into an agreement with the state. 

The MTC also claims that it does not disclose the agreement or any of its terms to any other state.

An applicant is not required to disclose any information that would reveal its identity prior to the execution of an agreement.

For more details on the program, go here.

Were you aware of the MTC's Multistate Voluntary Disclosure Program?

Have you used the MTC's Multistate Voluntary Disclosure Program?

If yes, was it a good experience? Pros and cons?

Leave a comment or e-mail me at strahle@leveragesalt.com.