A decade or so ago, interstate business travel in the United States wasn’t considered a significant tax issue, at least not to the extent that it is now. Many who traveled on business to states with income taxes didn’t know they could potentially be taxed for income earned there. Many employers who would have been required to withhold and report on this income were also largely unaware.
Today, though, that’s no longer the case, as awareness has increased exponentially. Technology now exists to easily identify interstate tax violations (which was prohibitively expensive in the past) and states have found they have much to gain by using it. This not only includes the tax revenue itself, but financial penalties levied for noncompliance.
As might be imagined, this is a growing compliance nightmare for many U.S. companies, since there are other consequences for noncompliance as well. This includes loss of a business license, damage to the company’s brand, and even imprisonment. That said, however, technologies to mitigate these risks are also now available.
Complexity a cause of noncompliance
Although some employees and employers willfully disregard non-resident tax obligations due to the time and expense involved, others fail to meet them due to their complexity.
As noted, companies must withhold and report on the income an employee earns while working in any state with an income tax. Currently, 41 states have one, seven have none (Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming), and two only tax investment income and dividends (New Hampshire and Tennessee). While some states may have similar withholding thresholds and requirements (based on the number of days within the state, income, or a combination of both), there is still considerable variation.
- Louisiana requires non-residents who must file federal tax returns to also file Louisiana state tax returns if they receive income from state sources.
- Maine requires non-residents to file state tax returns if they have enough income from state sources to trigger a state income tax liability. There are exceptions based on the number of days in the state, type of work, and the amount earned.
- Massachusetts has different income filing thresholds for residents versus nonresidents; non-resident thresholds are adjusted based on time spent in Massachusetts and are highly complex, much more so than for residents.
The ability to comply with various state requirements also depends on who’s working where. For example, a company that employs a few workers from a single neighboring state will only need to consider that state’s tax requirements. Companies that send multiple employees to multiple locations face a far more complex scenario, with more potential for error.
In addition to the above, there are other factors employers must take into account to remain compliant. This includes the requirement to register in any state where their employees are doing business – even if the company itself does not have a presence there -- in order to withhold and remit non-resident taxes.
Minimizing the tax impact on employees
Employers must also consider any negative tax impact on employees, and whether they’ll develop policies with gross-up and tax protection provisions to help alleviate this.
When companies don’t do this, it can mean a greater tax burden for some employees, which may then impact their willingness to travel and their overall level of engagement. Although states usually provide credits for taxes paid in other states, employees may not get the full benefits if the taxes are higher. For example, a New Jersey resident who travels to a higher-tax state like New York would receive a tax credit from New Jersey for the New York taxes that were paid, but it wouldn’t cover the entire amount.
Even less equitable scenarios would be those involving residents of states with no income taxes (e.g., Florida and Texas) doing business in states like New York. In these instances employees would receive no tax credit at all, as they had no income tax in the first place.
Another financial burden that employees incur with regard to this are fees to tax providers. Those who have done business in other states may need to have a professional determine if a return is required, and, if so, prepare it.
Foreign nationals working in the United States have additional issues. Although those from countries that have tax treaties with the United States typically receive some relief from federal income taxes (as the treaty exempts them), this may not be the case on the state level. A few states don’t recognize these treaties, so people working there would be subject to non-resident withholding they would be unable to recoup.
Compliance strategies and solutions
Now that states have intensified their tax enforcement efforts, companies still at risk for noncompliance are rapidly seeking solutions.
As this is an enormous task for all but the smallest organizations -- that no one person typically owns – it can be helpful to consult with compliance specialists to help determine the size of the issue, to identify risks and objectives, to define mitigation processes, and to promote collaboration among all applicable departments (e.g., mobility, HR, payroll, finance, and tax). Third-party consultants can also facilitate senior leadership buy-in, which will further promote compliance efforts and clarify the benefits to the company.
From there, next steps include establishing and implementing a process. A best practice is to begin with a pilot program, which can be reviewed and refined at regular intervals -- particularly the payroll portion -- until it reaches the desired state. This, however, could take a year or more before a company feels it is on solid ground.
Companies should also establish a process that is put into place any time it does business in a new state (especially those with complex tax issues such as Massachusetts) and that identifies who should be involved, notified, etc.
Beyond this, another key component of the compliance process is rigorous data management, which includes maintaining accurate employee location data and amounts and types of compensation. In addition to base salary, the latter includes long-term bonuses and awards and equity awards/stock options. This part of the solution should be scalable, as what may work for one part of the population may not work for another. For example, a process for capturing executive compensation may be different from that used to capture compensation for sales reps who travel; this would be due to the types of payments received by each type of employee.
Travel-tracking technology can help simplify this task considerably. This may include gathering travel data from various sources, including the employee and corporate travel providers. The tracking system compiles the data and evaluates each employee, as well as groups, against the configurable rules by state to assess risk, compliance, and threshold breaches. This information can be used by corporate clients to develop policies and procedures that will reduce the state to state business traveler compliance risks.
Although interstate business travel has become yet another compliance issue for many organizations, mitigation strategies and processes can be used to offset the risk. Also, simply putting these into place reduces risk as well: Should there be an audit, it attests to the fact that a company is making a good-faith effort to be compliant.