Discussion:Travelling Salesman-state taxes

What is a company's responsibility for tracking wages paid in travel to different states?

I've asked two colleagues this question and they come up with different answers, so I am looking for a consensus (1st one who answers either way will make a majority!)

The employer has due process/commerce clause nexus in every state where anyone, employee or not, regularly solicits orders for its products. Depending on the facts, the employer may be protected from income taxation by P.L. 86-272. But the employer must register as an employer and withhold state income tax unless the salesperson's contacts with the state are below a de minimis threshold. In addition, the employer must collect and pay over use tax on any retail sales of tangible personal property to residents of the state. The employer may also be subject to other state taxes such as net worth (franchise) taxes, gross receipts taxes, etc.

I have three clients on the periphery of Major League Baseball; they travel with a team and are subject to tax in various states. The three are paid by three separate employers; one whose 'tax home' and residence is in a state without an income tax is given W-2 forms reflecting withholding in ten states. The second, from a state in the northeast, files nine state returns. The third, from a mid-Atlantic state, only shows 5 other states. In our real world, I do not ask for his calendar for two reasons: (1) I believe the employer takes a certain responsibility, and (2) these men do not earn Alex Rodriguez type salaries, so that often income for states is less than $1,000.

I would note that up until two years ago, the man in the northeast did not pay tax in the state of the team's biggest rival, a high tax state.

I also see employers deduct taxes for Cleveland, Detroit, Kansas City, St. Louis and Philadelphia, small piddling amounts. This comes from the efforts of a Philadelphia lawyer who convinced the powers-to-be of that City that entertainers and athletes were not paying the wage tax, so his office went after them, [and earned a third of the collections for themselves, it is said]. He became a 'hero' for a while until he expanded his efforts, which included various means that were not quite legal. The Majority Leader of the Pennsylvania Senate went to jail when the misdeeds of his claque were revealed. The lawyer was put out of the tax collection business.

The effect of this lawyer's efforts was that other cities reciprocated; so did other states. I did the first of these MLB clients in 1997 and had four states. Now I do nine-ten. Their returns must be filed by paper because of an IRS rule about the number of states in those blocks.

So this is the real world; I would dread a day when all employers are as diligent as two of three major league teams.

Why cannot the travelling salesman be an IC? If he is a bona fide employee, then the employer HAS to do the reporting correctly. Too much at stake, since if he is making sales in a state and they want ANY liability protection under the law of that state, they have to be registered to do business in that state....

The difference between an IC and an employee, from the employer's perspective, is that the burden of compliance for the agent's individual income tax is shifted from the company to the individual. But the company still has nexus based on the agent's activities. Unless the IC represents more than one principal and holds himself out as so doing, he is subject to the same restrictions on his activities as an employee for purposes of determining whether the company is protected from income taxation by P.L. 86-272. The company is still subject to use tax collection and other taxes.

As D&T suggests, lots of individuals and companies fly under the radar, and my answers are from the "strict constructionist" point of view. But to use an analogy that I think was originally D&T's, if I run 100 red lights and never get a ticket, does that mean it's legal to run red lights?

In real life there is a cost-benefit analysis that is better made consciously than unconsciously. What is the cost of compliance, compared to the risk of noncompliance? Depends on the facts and circumstances and how risk-averse the individual or company tends to be.

Wayne's question was about the traveling salesman, but as our world evolves, we are going to find more of travel is done over the ether. That particular discussion involved the sale of insurance policies, where often the disclaimer is made that policies cannot be sold in certain states. Does the fact that the issuer is the gatekeeper, preventing residents of New York from buying, give him a nexus in any other state where residents are eligible to buy? Does the sale of the first policy in that state give that state enough of a nexus to tax the company, and the salesman? What about the fact that policies might need approval by each state's insurance department?

Insurance is regulated by state insurance departments, or is supposed to be, but what about the ladies and gentlement who come to your town and give 'seminars' on Living Trusts, or to sell plots of land in New Mexico, Arkansas etc etc?

If however he is INDEPENDENT and there is no sales tax nexus due to sales of tangible property, then the mere use of an IC to perform duties for the company (subcontract labor for instance) does not constitute nexus for the company.

If a company hires an IC sub to install his product, the installation of that product does not constitute nexus if the IC is INDEPENDENT and as you put it....performs services for others as well.

Again, I must be careful to say exactly what I mean and not what I think I mean :) hehehehe

Whether installation or warranty service performed by a third party creates nexus for the seller depends, generally, on the terms of the contract. There has been a lot of controversy about this since the MTC issued Bulletin 95-1 in 1995. Most states seem to be taking the position that if the installation is part of the sale contract, it creates nexus for the seller whether performed by the seller's personnel or by an unrelated third party. Similarly, if the warranty contract is between the seller and the customer, it generally creates nexus even though the seller contracts with a third party to perform the service. However, if the contract for installation or warranty service is between the customer and the third party, nexus for the seller generally is not created.

States vary in their application of these principles, so you do have to look at it state by state.

My goal is to not have clients run red lights, but if the employer is not reporting anything to these states, what is the employee's responsibility?

As to nexus, I think things are changing. It used to be that if a company didn't have a physical location in our state, they wouldn't have to charge sales tax on deliveries to the state. This is changing next year and all out-of-state deliveries into the state will now have to include sales tax.

Yes, each state defines it differently but for one of my clients who went through this process, he hired IC's in the states to install product lines and this did not constitute nexus for my client in these 3 states. Granted all these subs had income connected with working in the state and had to pay taxes to those states (where applicable) but it did not increase the burden to my client by forcing him to claim nexus on the same activities.

If however my client were to perform or deliver warranty work by virtue of these IC's, then that too is sales, or if my client were to consistently hire the same IC's to do the work in the state on a continuous manner, this could also be nexus creating. Simply hiring an IC out of the telephone book in a state to install a product that was purchased did not create nexus for this client....hopefully that is logical because if not, then it will put everyone out of business for interstate commerce....

It is not true that the taxation of nonresidents' income from services performed in a state is limited in any way to pro athletes and entertainers. Those are the most visible examples, but believe me, all of the major accounting, law, and consulting firms religiously report their employees' incomes to all of the states where they work.

I've told this story about a million times, but here goes again: in the late 1980s, the major accounting firm where I worked at the time was audited by the state of Colorado. The firm's consulting arm (which later split off into a separate partnership) had a large engagement (an ERP installation, I think) which resulted in several highly-compensated nonresident individuals spending months at the client's location in Denver. No Colorado or Denver city taxes had been withheld. There was talk of criminal prosecution. From that time on all of us were required by the firm to report on our time sheets not only the client code but also the location where we performed our services. From then on, until I retired in 2001, I had tax withheld and filed returns for four or five states every year. If you ask anyone who works and travels for a national or large regional accounting, law, or consulting firm, they will tell you the same thing. Of course, many smaller firms fly under the radar, and many are not even aware of their obligations.

My guess, Wayne, is that your client will find that tax is withheld for the states where he works based on his time reports. He'll have to file returns in all those states, if only to get his money back.

It's true that some states have de minimis rules like New York's. My experience, though, is that big organizations' payroll departments often can't be bothered to figure out what they are. They just withhold based on the employee' time reports and let the employee deal with it. So the employee may be under the de minimis threshold but still has to file a return to get the withholding back.

Congress could certainly place limits on states' authority to tax nonresidents' income from services performed in the state. It's already done so with respect to retirement income (HR 394, 4 USC Sec. 114, effective 1/1/96).

And don't even ask about when clients move from CT to PA, e.g. One client's W-2 still shows wages for CT and he moved in September 2004, received moving and relo expenses, and has notified the company several times. What is worse in this situation is that PA does not recognize 401K, but no tax is taken out for PA on that 20K contributed.

One way to make these requirements easier is to permit taxpayers to file electronically even though they might have 6-8 states listed in Blocks 15-17 of the W-2.

Yeppers; leave it to Dandy to be "gushy"...hehehehe