Payroll InsightsSeptember 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. IRS Releases Guidance on Supplemental Wage WithholdingThe Internal Revenue Service recently released a revenue ruling providing guidance with respect to nine situations involving payments of supplemental wages. For each example, the IRS described the facts and determined (1) whether wages at issue were considered supplemental wages subject to employer withholding under Internal Revenue Code (IRC) section 3402 and corresponding regulations and, if so, (2) whether the applicable withholding rate must be determined under the “aggregate” procedure or the withholding agent is required or permitted to use a flat rate. Treasury Regulation (Treas. Reg.) section 31.3402(g)-1 provides rules for determining whether wages are classified as “regular wages” or “supplemental wages.” This distinction may have significance in determining the amount of income tax required to be withheld. Generally, “supplemental wages” is defined as “all wages paid by an employer that are not regular wages.” “Regular wages” is defined as “amounts that are paid at a regular hourly, daily, or similar periodic rate (and not an overtime rate) for the current payroll period or at a predetermined fixed determinable amount for the current payroll period.” Accordingly, “supplemental wages” includes such wages as commissions, bonuses, tips, overtime pay, and other non-regular wages. If an employee has supplemental wages, the employer must determine the applicable withholding rate on such wages. As Treas. Reg. section 31.3402(g)-1 illustrates, there are generally three different procedures for determining the applicable withholding rate on supplemental wages. If a supplemental wage payment when added to all supplemental wage payments made by one employer to an employee during a calendar year exceeds $1 million, the employer must withhold at the highest marginal rate (mandatory flat-rate withholding). Generally, the employer may use the flat rate determined with reference to the applicable withholding table (optional flat-rate withholding) provided that:
If the employer is not required to use the mandatory flat rate and is ineligible to use the optional flat rate, the employer must use the “aggregate” method to calculate the withholding liability. Under the aggregate method, the supplemental wages, if paid concurrently with wages for a payroll period, are aggregated with the wages paid for that payroll period. If the supplemental wages are not paid concurrently with wages for a payroll period, the supplemental wages are aggregated with the wages paid or to be paid within the same calendar year for the last preceding payroll period or for the current payroll period, if any. The employer then calculates the amount of tax to be withheld as if the aggregate of the supplemental wages and the regular wages constituted a single wage payment for the payroll period. It is important to note that, while the aggregate method is sometimes required, as long as the wages are not subject to mandatory flat-rate withholding, it is always permitted. Revenue Ruling (Rev. Rul.) 2008-29 (July 12, 2008) provides nine examples. For each example, the IRS determined whether the wages constituted supplemental wages and, if so, the corresponding withholding procedure (i.e., mandatory flat rate, optional flat rate, and aggregate). The nine situations and corresponding conclusions are summarized below. These summaries do not address the payroll period, which is addressed by the revenue ruling. Click here to access Rev. Rul. 2008-29.
IRS: Employee Leasing Company Not “Employer” for Unemployment Tax PurposesIn a Chief Counsel Advice Memorandum, the IRS denied a federal unemployment tax (FUTA) refund to an employee leasing company (ELC) because the ELC was not considered the employer for FUTA purposes. The taxpayer at issue provided staffing services to businesses in conjunction with employee benefit and payroll services, including withholding, depositing, and reporting all applicable state and federal employment taxes. The taxpayer paid FUTA on behalf of its clients but subsequently filed for a refund of FUTA, arguing that it was eligible for an exemption under IRC section 3306(c). Under IRC section 3301, FUTA is imposed on each employer—as defined in IRC section 3306(a)—with respect to “wages” paid to individuals in its employ. “Wages” are defined in IRC section 3306(b) as “all remuneration for employment, including the cash value of all remuneration,” with certain exceptions. Additionally, IRC section 3306(c) defines “employment,” in pertinent part, as any service by an employee for the person employing him. The definition explicitly notes several exceptions to the definition of “employment,” including certain agricultural labor, certain services performed for the state and federal government, and certain services provided to nonprofit organizations. The taxpayer filed for a refund of FUTA on the basis that its employees were engaged in these excepted activities, thus claiming that remuneration paid to these employees was not considered “wages” and, accordingly, the payments were not subject to FUTA. The IRS asserted that the taxpayer was not entitled to a refund because the taxpayer was not the employer under IRC section 3306(a). The taxpayer argued that it was the employer of the workers with respect to whom FUTA had been paid because it was considered their employer for purposes of both federal income tax withholding and state unemployment tax. The IRS countered that Treas. Reg. section 31.3306(i)-1 provides that an individual is an “employee” if the relationship between him and the person for whom he performs services is the legal relationship (i.e., common-law relationship) of employer and employee. The IRS noted that the fact that the taxpayer was considered the employer by statute under the federal income tax withholding provisions and state unemployment tax law was irrelevant to whether the taxpayer was a common-law employer. The IRS observed that a common-law employer/employee relationship exists when an entity has the right to direct and control the performance of individuals. Under the facts, the IRS determined that a common-law employer/employee relationship did not exist because the taxpayer did not provide workers with any specific instructions as to when, where, or how the work will be done. Rather, such instructions were given by the business that leased the workers. Accordingly, the taxpayer was not considered an “employer” entitled to a refund. Although this determination is not particularly friendly to the taxpayer at issue, practitioners and ELCs should keep two points in mind. First, a Chief Counsel Advice Memorandum may not be used or cited as precedent. Second, if an ELC has not contracted to pay FUTA on behalf of a business, the ELC may not be responsible for FUTA despite being required to withhold income tax and pay state unemployment insurance for the workers. Practitioners and businesses leasing these types of employees should be aware that refund opportunities might be available for these businesses as they may be considered to be the “employer” for FUTA purposes, thus entitling them to an exception under IRC section 3306(c). For more information, see Chief Counsel Advice Memorandum 200827007 (March 10, 2008). Multistate RoundupCalifornia: Franchise Tax Board Launches Nonresident Withholding AuditsIn the August 2008 edition of Tax News, the California Franchise Tax Board (FTB) announced that it is conducting audits of nonresident withholding. Under California law, withholding generally is required on payments to nonresident independent contractors of “compensation for personal services” rendered in California. “Compensation for personal services” includes, for example, sales commissions, professional fees, and contracted services payments. Withholding is not required on the first $1,500 paid to a nonresident independent contractor in a calendar year. In the guidance, the FTB noted that it is assessing the required 7 percent nonresident withholding liability on entities that fail to withhold in addition to a $100 penalty for each informational return not filed. In the course of conducting withholding audits, the FTB identified three common errors:
The guidance reminds taxpayers to properly categorize independent contractors and employees and warns taxpayers that after compliance audits, the FTB may refer taxpayers to the IRS or California’s Employment Development Department for audit. Interestingly, under other guidance promulgated by the FTB, Publication 1017, the FTB has noted that interest also is required to be assessed on late payments of withholding. Presumably, the FTB will continue to assess interest on amounts an entity fails to withhold. Additionally, in Publication 1017 the FTB notes that a $100 penalty for failing to file an informational return applies only if the failure is due to an intentional disregard of the requirement. According to Publication 1017 and Cal. Rev. & Tax Code section 19183, the penalty for failing to file correct informational returns is $50 in cases when the failure is not due to an intentional disregard of the filing requirement. Colorado: Unemployment Tax Legislation Signed Addressing Employee Leasing CompaniesOn May 20, 2008, the governor of Colorado signed Senate Bill 08-114 addressing employment tax responsibilities of employee leasing companies (ELCs). The law, effective August 6, 2008, clarifies that ELCs are required to pay unemployment insurance taxes for all employees covered under an ELC contract. Generally, an “employee leasing company” is a company that provides employees to another business (the work-site employer). The new law requires that ELCs obtain certification from the Colorado Department of Labor and Employment. Senate Bill 08-114 clarifies that an ELC must “pay wages and collect, report, and pay all payroll-related taxes from its own accounts for all covered employees.” Specifically, the ELC —and not the work-site employer—must pay unemployment compensation insurance taxes. The legislation also requires that the ELC annually provide the department with certain documentation to ensure that it has sufficient funds to meet its unemployment tax obligations. Connecticut: Legislation Signed Addressing Professional Employer Organizations, Employee MisclassificationOn June 2, 2008, the Governor of Connecticut signed Substitute House Bill 5113 addressing professional employer organizations (PEOs) and employee misclassification. The new law clarifies that effective January 1, 2009, PEOs—sometimes called employee leasing companies—generally will be required to withhold, collect, report, and remit “payroll-related and unemployment taxes.” In addition, PEOs must:
Substitute House Bill 5113 also establishes, effective July 1, 2008, a “joint enforcement commission on employee misclassification.” The commission will:
Iowa: Independent Contractor Reform Task CreatedOn July 16, 2008, the governor of Iowa signed Executive Order Number Eight to establish an Independent Contractor Reform Task Force. The executive order noted that misclassifying employees as independent contractors has serious adverse effects on the collection of employment taxes. Accordingly, the task force will:
New Jersey: Family Leave Insurance Legislation EnactedOn May 2, 2008, the governor of New Jersey signed Assembly Bill 873 (A.873) to provide paid family leave benefits to employees caring for certain family members. The legislation was enacted to protect New Jersey workers from a loss of income in the event that the workers would need to take an extended leave of absence to care for family members who are incapable of self-care. Under A.873, workers covered by New Jersey’s unemployment compensation law will also be covered by “Family Leave Insurance.” Covered employees are eligible for six weeks of benefits to care for certain family members with “serious health conditions” or to be with a child during the first 12 months of the child’s birth or adoption. The program will be funded entirely by employee payroll deductions, requiring no contributions from employers. Beginning January 1, 2009, New Jersey employers will be required to withhold an additional 0.09 percent of employees’ wages to finance the Family Leave Insurance program. New Jersey employees will be subject to the additional withholding on wages earned up to the state unemployment insurance taxable wage base ($28,900 for 2009). For calendar year 2010 and subsequent years, the withholding rate increases to 0.12 percent. Employers should report the wages and submit payment with Form NJ-927, Employer’s Quarterly Report. Under the new law, an employer is not required to withhold additional wages if the employer is covered by an approved private disability plan for benefits during periods covered by the Family Leave Insurance program. Employers considering this alternative must receive prior approval from the New Jersey Division of Temporary Disability Insurance. Although withholding is required beginning January 1, 2009, employees may not apply for Family Leave Insurance benefits until July 1, 2009. Oregon: Director’s Fees Not Wages for Unemployment Tax PurposesThe Oregon Supreme Court recently overturned an Oregon Court of Appeals decision (covered in the September 2007 edition of Payroll Insights) and held that fees paid to directors of a corporation were not wages subject to the state’s unemployment tax. The taxpayer at issue paid $18,000 in directors’ fees to three board members, but did not pay unemployment taxes on these amounts. Following an assessment of unemployment tax, the taxpayer unsuccessfully sought an abatement of the tax before an Administrative Law Judge (ALJ) and the Oregon Court of Appeals. On appeal to the Oregon Supreme Court, the taxpayer argued that the directors' fees were not wages under Oregon law because wages are defined as remuneration for employment and the directors were not employees of the corporation. The court observed that both the ALJ and the appellate court had assumed that the directors were employees and therefore focused their analysis on whether the wages were subject to unemployment tax. However, focusing its inquiry on whether the directors were in fact employees, the court examined the statutes regulating corporations and directors to determine how the legislature had intended to define the nature of the relationship between a director and a corporation. The court observed that one provision of Oregon law specifically stated that an “employee” of a corporation includes an officer but not a director. Furthermore, other unemployment insurance and tax statutes also supported the legislative recognition that a director is not an employee. The court noted that directors do not take directions from corporate officers or agents, and directors are not hired and fired by the corporation, but are elected and may be removed by the shareholders of the corporation. Thus, the court concluded that there was no employer-employee relationship between the corporation and its directors when the directors performed their statutory duties. Accordingly, the court concluded that the legislature did not intend to include corporate directors serving solely as directors within the statutory definition of an employee for unemployment tax purposes. Necanicum Investment Co. v. Oregon Employment Department (July 24, 2008).
|
Unsubscribe | Privacy & Disclaimer © 2008 KPMG LLP, a U.S. limited liability partnership
and a member firm of the KPMG This message has been approved for distribution by Scott Schapiro. |
