Here and there, a CPA's travelogue
State and local tax considerations for traveling employees
April 2018 Footnote
When you have employees traveling to other states for work-related purposes, there are a number of different tax types that may come into play. It's important to know the differences between states' statutes, and how and when nexus is created by an employee through state and local taxes. Otherwise, you might find yourself heading down the wrong road.
Employment-related taxes, such as unemployment insurance reporting or wage withholding, are usually the first that come to mind. At what point is an employer required to register in another state and report those wages to that state agency? As with many tax-related questions, the answer all too often is, "It depends." Reporting requirements vary, from requiring nonresident withholding on the first day of travel within a state to various other thresholds.
For example, in Colorado, an employer is required to withhold Colorado income tax on any amount of compensation paid to an employee, if the compensation is subject to federal withholding for income tax purposes.
However, in Minnesota, an employer is not required to withhold Minnesota tax from nonresidents who will earn less in Minnesota wages than the minimum income required to file a Minnesota individual income tax return. The minimum filing requirement changes each year, and is equal to one standard deduction for a single filer, regardless of the employee's filing status, plus one personal exemption. For 2018, this amount is $10,650.
Illinois takes a different approach entirely. No withholding is required, even if an employee performs services in Illinois, when that employee's primary location "base" of work is outside of Illinois.
Lastly, other states such as Arizona, Connecticut and New York, among others, have a certain threshold of days per calendar year which, if exceeded, would require withholding on the nonresident employee.
Exceptions for withholding
Several states offer reciprocal agreements for wages paid to nonresident employees. This makes it important to determine if such an agreement exists, and then ensure that the proper documentation is obtained.
A reciprocal agreement (commonly referred to as reciprocity) is an agreement between two states that allows an exemption from tax withholding to be requested by a resident of a state from another participating state. This eliminates the requirement of employees to file an income tax return in the state where they are not a resident. Without such an agreement, employees are required to file a tax return in their state of residence as well as the state where they worked (and to which they paid withholding).
Minnesota currently has reciprocal agreements with Michigan and North Dakota. Therefore, if a Michigan employee travels to Minnesota for work, the employer is not required to withhold for the nonresident employee for services performed in Minnesota if the employer obtains a completed Form MWR from the employee, and timely remits the form to the Minnesota Department of Revenue. Some states, such as Kentucky and Michigan, have reciprocal agreements with as many as six or seven other states.
Unemployment compensation is generally reported to the state where the employee's primary base of work is. Most states provide guidance and a hierarchy to assist in determining which state to report if the employee travels frequently or doesn't have a primary work location.
Employees traveling to other states may create nexus for sales tax as well as income tax purposes in those locations. If the employees are traveling to another business location, then the business already has nexus in that location and there isn't an added element of exposure in that situation. However, if the employee is traveling for a trade show, to meet with an existing or potential client or to provide services in another state, those activities could subject the business to new tax reporting requirements.
Sales tax nexus is created when an employee travels into a jurisdiction with any level of frequency to generate business, meet with customers, provide services, etc. Unfortunately, many states do not provide a clear answer of just what "frequently" means. In Minnesota, Revenue Notice 00-10 states that once four days of business activity in Minnesota within a 12-month period is met, the business is required to register, collect and remit Minnesota sales or use tax on Minnesota-sourced sales.
If a state determines that the business was subject to reporting, an assessment can be made for sales tax that should have been collected and remitted by the business even if it was never collected.
Income tax nexus can often be created in the same manner, depending on what the employee is doing in the state. Certain businesses may have protection from traveling employees under Public Law 86-272, but it is important to clearly understand what activities are protected as well as what activities employees are actually doing. Often, businesses think they were protected and later find out that the activities being done in the state went beyond what was protected, or misunderstood the application to apply to businesses other than those only selling tangible goods.
It is important to note that independent representatives, not just employees, can create nexus as well.
When employees are traveling and being reimbursed for incurred travel expenses, ensure that a system is in place to obtain and maintain proper documentation for all expenses. In the event of an audit, the agent is most likely going to want to review receipts, invoices and other documentation. Undocumented expenses may be disallowed. From a sales tax standpoint, undocumented reimbursement amounts could be assessed for sales tax with the position that the burden of proof is on the taxpayer to prove that it was not an untaxed taxable purchase.
Take a two-pronged approach
From a sales tax and income tax standpoint, it is very important to consider possible nexus-creating activity from a two-pronged approach. Consider what level of activity the business has in a state paired with what the possible liability or exposure for that state is. Do not forget to take into consideration penalties and interest associated with noncompliance, as well as the lack of a statute of limitations. Some states have higher interest rates and significant penalties for noncompliance, which can change a small amount of perceived exposure to a much higher amount. Also keep in mind, if the business was not registered and filing in that jurisdiction, there is not a limited lookback period as the statute of limitations would not apply.
Keeping track of dates and locations of travel can be a burdensome task. However, it is very important to maintain compliance. As an example, a withholding audit where the state determined wages should have been reported to their state rather than another state resulted in an assessment of those withholding amounts to the business. Following the audit, the business needed to amend the W-2s for all affected employees to correct the withholding for the assessed state. The business also needed to explain the change to the employees, which required them filing amended returns for both states to recoup the additional withholding originally reported to the incorrect state, and require a repayment from the employees.
Having assisted businesses through similar audits, the time it takes to correct the reporting, explain changes to affected employees, as well as the significant possibility of assessments, should all be reason enough to be aware of where and how often you have employees in other states.
Sarah Hopkins is a senior manager at Baker Tilly Virchow Krause, LLP. She has 13 years of experience in state and local taxes. Prior to joining Baker Tilly, Sarah worked for the Minnesota Department of Revenue. There, she conducted sales and use tax as well as individual income tax audits, participated in sales and use tax policy decisions, and sales and use tax legislation. You may reach her at firstname.lastname@example.org or 612-876-4899.