As we move deeper and deeper into the 21st century, the nature of business continues to metamorphose in surprising and challenging ways. One of the greatest contributors to this change is the increasing mobility of the current workforce, which has led employers and companies to depend on non-cash incentives to keep employees in the fold. One of the more popular non-cash incentives is the flexible work arrangement. This arrangement allows employees to work non-standard hours in various locations, usually with minimal changes to compensation— an immensely beneficial arrangement for many employees. However, despite the flexibility of this arrangement, there are several challenges that could deteriorate into significant problems for the unwary—among them, several tax traps. These challenges deserve serious consideration, but they also might present some golden opportunities.
Challenges
Employee vs. Contractor Classification – Once team members are working in other locations with reduced hours, the line between employer and contractor begins to blur. While some businesses might be tempted to classify these team members as contractors to minimize various benefit and insurance costs, care must be taken in this area. Employee classification is heavily litigated, and while each business will want to examine its own facts and circumstances, classifying team members as contractors is extremely risky if the business maintains any control over various aspects of the team member’s behavior.
Payroll Tax Compliance and Withholding Obligations – As soon as a business has team members in jurisdictions besides the business domicile, the volume of payroll tax filings can exponentially increase. Because state unemployment liabilities are usually small amounts, the additional filing and remittance obligations can easily be missed, but the ramifications of doing so could be significant. Employees within different states also introduce variability into the state income tax withholding obligations, which can be difficult to track, particularly for small businesses.
Income Tax Nexus – While many states are moving away from the traditional “physical presence” nexus standard, the “factor presence” and “economic presence” nexus standards also lend weight to the existence of payroll activity within a given jurisdiction. State taxing authorities can easily identify situations where payroll tax or income tax withholding has been paid, but no related income tax filing has been submitted. Even when employee activities are protected under the interstate commerce clause, businesses usually are required to file returns to claim that protected status.
Opportunities
While there are definite challenges to a decentralized workforce, there also are opportunities to help ease the burden of multi-jurisdictional filing.
Tax Incentives for Hiring and Training – Just as the federal government detests losing jobs overseas, states dislike losing jobs to other jurisdictions. One of the ways states try to attract new businesses (and retain those businesses already within their borders) is through the design and legislation of significant incentive programs. While many of these incentives are designed for companies making significant capital investment and workforce hiring commitments, even small businesses can benefit from analyzing what credits are available. There are tax credits for hiring workers who live in economically distressed communities, have served in the military, or have been recently incarcerated. States provide businesses with training (through state-taught classes, or cash-for-training programs) or other incentives to hire or retain talent in their state. While many of these incentive programs would require some economies of scale to justify the time and expense of the application process, others are relatively easy to claim, and are worth considering, even on a small scale.
State Nexus and Apportionment Planning – While most businesses would see generating nexus in other jurisdictions as a bad answer, there are times when it can benefit the business by lowering the overall tax burden. If a business domiciled in a high-tax state has employees working in low-tax jurisdictions, the ability for that business to apportion income to the low-tax state can lower the effective tax rate and reduce the overall cash outlay for taxes. The impact of apportionment planning can be even more dramatic for businesses domiciled in “right-to-apportion” states. Businesses based in “right-to-apportion” states recognize 100% of their income in that home state, unless that business has nexus in another state, and therefore, the right to apportion income to their home state. If you apply this change to a manufacturer who has sales across the country, the resulting reduction in the business’s effective tax rate can be very beneficial.
If your business is considering implementation of a flexible work arrangement that crosses state borders, or if you want to talk about other tax planning or incentive opportunities that might exist, contact one of the related experts listed below at PYA (800) 270-9629.
