Payroll InsightsJuly 2008
About This NewsletterPayroll Insights is a publication from KPMG LLP’s Employment Tax Practice. It is designed to provide you with current developments in the payroll and employment tax arena and will be published periodically throughout the year as developments warrant. Heroes Earnings Assistance and Relief Tax Act of 2008 EnactedOn June 17, 2008, President Bush signed H.R. 6081, the Heroes Earnings Assistance and Relief Tax Act of 2008 (Heroes Act). The new law contains several employment tax provisions relating to (1) payments made by civilian employers to active military personnel and (2) employers subject to tax liability and withholding under the Federal Insurance Contributions Act (FICA). Differential Pay Treated as Wages for Income Tax WithholdingWhen employees are called away from civilian employment to active military duty and their active-duty military wages are less than the wages from their civilian job, some employers voluntarily pay the difference, or a portion of the difference, in compensation—an amount known as “differential pay.” Currently, differential pay is not treated as wages for federal income tax withholding purposes. The Heroes Act amends the definition of wages to include differential pay in income subject to federal income tax withholding for amounts paid by employers after December 31, 2008. In addition, from the date of enactment until December 31, 2009, certain small-business employers may take a federal income tax credit equal to 20 percent of the sum of eligible differential wage payments. Foreign Employers Subject to FICAThe Heroes Act also addresses taxes imposed under FICA. FICA taxes are shared equally by an employer and its employee. However, the employer is responsible for withholding the employee’s share of FICA taxes. Generally, all remuneration for employment is included in wages subject to FICA taxes. “Employment” for FICA purposes includes services performed by an employee for an employer within the United States. Employment also includes services performed by a U.S. citizen or resident employee for an “American employer” outside the United States. Generally, work performed by a U.S. employee for a foreign employer outside the United States is not considered employment for FICA purposes. This exclusion has become a cause for concern given the increasing numbers of Americans working abroad for foreign employers under U.S. government contracts, particularly in Iraq and Afghanistan. Under the Heroes Act, some foreign employers will be considered American employers for FICA purposes and, as such, will have a tax liability and a withholding obligation. Foreign employers will be treated as American employers with respect to an employee if the employee is performing services in connection with a contract between the U.S. government and any member of a “domestically controlled group of entities” including the foreign employer. A “domestically controlled group of entities” means a controlled group of entities whose common parent is a domestic corporation. A “controlled group of entities” generally means a group of corporations connected through stock ownership with a common parent when (1) at least 50 percent of the stock (by voting power or value) of each subsidiary is owned by the parent or another corporation in the group and (2) the common parent owns at least 50 percent of the stock (by voting power or value) of at least one of the other corporations. A “controlled group of entities” can also include certain partnerships or other non-corporate entities. The result is that when a foreign subsidiary of a domestic corporation employs an American to work on a U.S. government contract abroad, the foreign subsidiary will be subject to FICA tax liability and withholding. Furthermore, the Heroes Act makes the domestic parent jointly and severally liable for FICA taxes. Wages not subject to FICA under exceptions provided in Internal Revenue Code sections 3101(c) and 3111(c) (Relief from Taxes Covered by Certain International Agreements) and section 3121(l) (Agreements Entered into by American Employers with Respect to Foreign Affiliates) are unaffected by the Heroes Act changes. Furthermore, if an employer establishes that the wages paid to an employee are subject to a tax by a foreign country that is substantially equivalent to FICA tax liability (i.e., the foreign tax is at least 80 percent of total FICA tax liability), a foreign employer will not be treated as an American employer for FICA tax purposes. Compromises Possible on Mobile Workforce State Income Tax Fairness and Simplification ActIn August 2007, H.R. 3359, the Mobile Workforce State Income Tax Fairness and Simplification Act of 2007, was introduced in the U.S. House of Representatives. The bill would (1) impose a 60-day in-state presence threshold before a state could require a nonresident employee to file an income tax return in the nonresident state and (2) provide that an employer’s withholding obligation is not triggered until the 60-day threshold is met. The legislation was drafted in an attempt to resolve inconsistencies among states regarding when a return filing obligation or an employer withholding obligation exists with respect to nonresident employees. The bill would provide that a nonresident employee may not be subject to income tax in a state or locality unless the employee resides in that state or locality or is physically present there for more than 60 days. The employer would not have to report or withhold tax from the employee’s wages until the employee is subject to income tax in the state. The bill defines “day” as any day when the employee is physically present in the jurisdiction and performs more than 50 percent of his or her employment duties in the jurisdiction. No action has been taken on the bill since November, when a House subcommittee held a hearing on it. One reason for the delay on the legislation is that organizations such as the Federation of Tax Administrators (FTA) oppose it. Hoping for a compromise, the Council on State Taxation (COST) and the American Payroll Association (APA) have suggested that the 60-day threshold be reduced to 45 or 30 days. The FTA would also be more likely to support the legislation if it included a dollar threshold in addition to the day threshold. That is, the state income tax would apply to persons who either work in the state for a specified number of days or earn more than a specified amount of money in the state. COST and APA, however, argue that a dollar threshold would be administratively difficult because it would require an employer to constantly monitor the compensation each employee has earned in the state or locality. However, COST and APA would consider a shorter day threshold that would apply only to high earners. Under that approach, high earners would be identified according to the previous year’s wages, thus avoiding administrative concerns over an employee becoming subject to tax mid-year because of an increase in earnings.
Many States’ Unemployment Insurance Trust Funds Vulnerable to RecessionThe National Employment Law Project (NELP) recently issued a briefing paper discussing the status of states’ unemployment insurance trust funds. Unemployment insurance trust funds, financed primarily through employer contributions, are required by federal and state law to ensure that a state is able to pay unemployment benefits. The trust funds are particularly important in times of recession as employers’ contributions decrease and the need for unemployment benefits increases. The NELP study analyzed the solvency of each state’s unemployment trust fund and came to several conclusions:
NELP suggests a number of policies to maintain or restore unemployment insurance trust fund solvency, including increasing the taxable wage base and increasing the minimum and maximum unemployment insurance tax rates. Maryland: Withholding Exemption Certificate RevisedThe Comptroller of Maryland recently revised Form MW 507, Employee’s Maryland Withholding Exemption Certificate, to reflect recent tax law changes that will affect the number of exemptions to which employees are entitled. The number of exemptions granted will decrease under the revised form for the following employees:
Any employee who falls under one of the categories above should file a new Form MW 507. The form also includes a revised worksheet for calculating personal exemptions. Pennsylvania: Senate Bill 1063 Simplifies Local Withholding RequirementsOn July 2, 2008, Pennsylvania Governor Ed Rendell signed Senate Bill 1063, making significant changes to the withholding and collection of local earned income taxes. Under Pennsylvania law, cities, boroughs, towns, townships, and most school districts are authorized to levy an earned income tax. Most municipalities and school districts have enacted such taxes, resulting in nearly 2,900 different taxing jurisdictions. Employers are required to withhold and remit local earned income tax. The number of taxing jurisdictions in conjunction with convoluted state law requirements has led to a number of problems for employers, including (1) varying definitions of taxable income based on jurisdiction, (2) differing withholding requirements based on jurisdiction, (3) unannounced changes in tax rates, and (4) burdensome reporting requirements under which employers had to report to multiple—in some cases hundreds of—tax collectors. In a 2004 study detailing these problems, the Pennsylvania Department of Community and Economic Development concluded that the “dysfunctional” collection system caused a loss of more than $100 million annually. Senate Bill 1063 amends the Local Tax Enabling Act, passed on December 31, 1965, to address many of the withholding problems. First, the new bill provides many uniform definitions—including a definition of taxable income—and withholding requirements for all taxing jurisdictions. Second, the bill provides that rates can be changed only twice yearly, and changes will be continually updated in a comprehensive tax register. Finally, the number of local earned income tax collectors is reduced from 560 to 69, and each employer will remit taxes to a single collector. Utah: Senate Bill 189 Establishes Independent Contractor DatabaseOn March 17, 2008, Utah’s governor signed Senate Bill 189, the Independent Contractor Database Act. The bill was enacted to provide for the creation of an independent contractor database that will identify persons classified as independent contractors. The database will include a process to compare the information in the database at least monthly to identify workers who may be misclassified as independent contractors and to promote employer compliance with state and federal employment tax laws. The information in the database will be available for use only by certain state agencies. Those agencies can disclose the information in the database only if administrative action needs to be taken, to prosecute a criminal act, or to the extent that the information is available from a source other than the database and is permitted to be disclosed by law. The bill also creates an Independent Contractor Enforcement Council charged with designing and implementing the database by no later than July 1, 2009. In addition to implementing the database, the Council must report on its effectiveness. The Council is permitted to study a number of things, including how to: (1) reduce costs resulting from the misclassification of workers, (2) extend outreach and education regarding independent contractor status requirements, and (3) promote information sharing among the agencies.
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