As my readers know, because we’ve covered this topic ad nauseam here in the NASPP Blog (e.g., see entries on December 13, 2012, December 6, 2012, August 10, 2010, and May 6, 2010) when employees holding stock awards travel from state to state, it may be necessary to allocate the taxable income they recognize upon settlement of their awards to the various states where they provided services during the life of the awards. This can apply not only to employees that relocate or that live in one state and work in another, but also to employees on assignment and even business travelers. Many states require employees that work as little as one day in the state to pay income tax in that state. To further complicate matters, the formulas used to allocate the income can vary from state to state.
With some states (most notably NY and CA, but there are others as well) implementing audit initiatives and actively pursuing enforcement in this area, this issue has moved to the forefront in terms of things that keep stock plan administrators awake at night.
Relief?
Given the complexity of the acronym, it’s hard to believe the Mobile Workforce State Income Tax Simplification Act (MWSITSA? mew-sit-sa? really?) is about simplification but there it is, the word “simplification,” right there in the title. The Act would accomplish this by prohibiting states from taxing non-residents that work in the state for less than 30 days during the calendar year. Moreover, the determination of whether or not the company has to withhold taxes could be based on employees’ expectations of how many days they’ll work in states other than their state of residence (in the absence of fraud, collusion to evade taxes, or some sort of daily attendance tracking system).
A memo from PwC in the NASPP’s State Taxes Portal provides a great summary of the Act (the memo refers to an earlier version of the bill but I believe it is substantially the same as the current version.)
Not So Much?
This would be a big help in terms of business travelers, but there would still be employees on temporary assignment and employees that relocate to contend with. And, even with business travelers, I can imagine plenty of situations where this bill wouldn’t help (e.g., a salesman with an out-of-state territory or a regional division head that spends a lot of time traveling to headquarters in another state). And the bill doesn’t seem to do anything about standardizing the formula for allocating income among jurisdictions.
My impression is that, so far, most companies’ compliance efforts have focused on relocations and assignments and that no one has been doing much in terms of compliance for business travelers anyway. But at least if the Act became law, you could cross business travelers off your list of long-term projects–well, as least some of them.
Which brings us to the $10 million question–will the Act get passed. I think there’s a good chance that legislation of this sort will be enacted some time during, say, my lifetime (note that I expect that I’ve got at least three or four decades ahead of me). But I’m not holding out a lot of hope for the short term. The good news is that a version of this bill was introduced into the House last year and passed. Unfortunately it stalled out in the Senate and now we’re in a new session of Congress so it has to start all over again. Govtrack.us gives it a 40% chance of making it out of committee but only a 6% prognosis of actually being enacted. At least there’s hope for our grandchildren…
What happens when an employee moves to another state while holding an equity award (e.g., stock option, restricted stock, restricted stock unit, etc.)? In many cases both states, (the state the employee moved from and the state the employee moved to) will tax all or part of the income related to the award.
Historically companies have not tracked employees moving from state to state. Companies have merely reported the equity compensation in the state of residency when the taxable event occurs (e.g., exercise of an option or vest of a restricted stock/restricted stock unit). Rutlen Associates recently conducted a survey of how companies track employee movement and report equity awards for employees that move from state to state. (Approximately 150 companies participated in the survey.) The survey results indicated about 20% of survey respondents meet the withholding and reporting requirements for reporting equity awards for mobile employees. Compliance varies depending on the type of mobile employee. Compliance is higher for employees on temporary assignment and employees permanently transferring to a new state. Compliance for business travelers is significantly lower.
In the Rutlen Associates’ survey the reasons for noncompliance vary:
50% could not allocate the income to more than one state because of limited system functionality and/or manual resources.
38% determined the amounts were insignificant.
35% didn’t know the compliance requirements for each state.
27% didn’t have information about employee movement.
Information about employee location/movement is more readily available for permanent transfers than temporary assignments and business travelers. Frequently the change of address when an employee permanently moves to a new state provides better documentation of employee movement.
Despite the challenges associated with compliance, more companies are reassessing the way they track and report state-to-state moves. Increased attention from the tax authorities in various states is encouraging companies to reevaluate their processes. Many states, especially New York and California, are focusing on enforcement of the withholding and reporting requirements for individuals moving into and out of the state. For example, New York is targeting high-level executives. During a recent audit New York State revenue agents reviewed payroll and expense reports for all executives–even executives with no ties to New York. Any company doing business in New York may be selected for this additional scrutiny. For many companies the potential tax assessment may not be significant, but the administrative cost of complying with the requested documents may be onerous.
Many software vendors are adding functionality in the stock plan database to track the historic location of the employee and employee mobility. Of course, adding functionality to track employee movement is a double-edged sword. The improved functionality makes compliance easier–knowing which employees are moving and the move date is the first step to complying with the reporting and withholding requirements. Once you have information on employee movement, however, the tax authorities are less likely to tolerate noncompliance and more likely to assess penalties for ignoring the compliance requirements.
The moral of this story is that it is an excellent time to reevaluate your handling of the issues surrounding state mobility.
Domestic mobility can be as complex as international mobility, but it certainly gets less press. With state governments dealing with budgetary difficulties, state tax authorities will be looking to capture as much “lost” tax revenue as possible. There are many situations where an individual may be required to report income and pay taxes in one or more states other than their state of residence, and stock option income is no exception. Most states follow federal income tax treatment for equity compensation, but only some specifically address how equity compensation should be sourced when mobility is an issue. For this reason, it really is best to get tax advice before creating a policy on domestic mobility.
Identifying Mobile Employees
There are three main situations that can lead to equity compensation being sourced to more than one state. The first, and probably easiest, is a permanent move made by an employee or former employee. When an employee or former employee moves from one state to another, you generally only need to assess the income sourcing once and then apply it to equity compensation going forward. Next on the list are employees that work outside their state of residence. This is most likely in the New England states where commuting across state lines can be quite common. Finally, there are employees who perform services for the company in more than one state. These situations can be the most challenging for stock plan mangers not only in determining compliance, but also in simply obtaining the travel information. Unlike with moves or permanent transfers, the details surrounding business trips or temporary assignments may not be evident in standard employee demographic details and must be communicated to the stock plan management team separately.
Sourcing Issues
When it comes to equity compensation, the key to handling domestic mobility is identifying when your company has an obligation to report or withhold on income from stock plan transactions in more than one state, or in a state other than your employee’s state of residence. Once that is established, the next step is to understand how each state sources the income. In many cases, the sourcing is between the grant and the exercise date for options (or vesting date for restricted stock). However, some states only consider residency at grant or at exercise and some completely have unique parameters.
Just like with international mobility, there will likely be situations of double taxation. States generally tax residents on all equity income, regardless of where it was earned. Alternatively, many states will also tax non-residents on equity income considered to be earned in that state. To address double taxation, there may be tax credit available to employees in either their state of residence or the non-residence state where equity income is earned. Additionally, some states have specific reciprocity agreements between them to avoid double taxation. It may be possible for your company to rely on these arrangements when reporting and withholding on equity compensation.
Steps to Compliance
A great way to tackle domestic mobility compliance is to start with the most visible (i.e. riskiest) and most common situations. Check to see if you have particular locations or employee segments where mobility is more common and determine which types of sourcing issues you are dealing with. Once you have an idea of what mobility issues you are going to address first, get informed on the sourcing and taxation requirements for the states in question. You can find information on our site in the State and Local Tax portal, but before making any decisions, consult your company’s tax advisor. Once you’ve made decision on how your company will handle specific situations, document a clear policy and run it past your auditor for confirmation.