The Mobile Workforce State Income Tax Simplification Act

I was glad to see that Senator Sherrod Brown (D – OH) introduced the Mobile Workforce State Income Tax Simplification Act on August 2, 2012.  The bill is being promoted by the American Institute of CPAs, and a version of the bill passed the House on voice vote May 15^th.

The bill would establish a uniform standard for the withholding of state income taxes on nonresident employees.  It would lessen the burden the current system places on employers and traveling employees. 

Both bills would require nonresidents to work in a state for more than thirty days before becoming subject to a state‘s income tax withholding.

Why is this an issue? Let’s say that you start a consulting firm. Business takes off. You develop a national client base and hire employees. You send your employees throughout the country, sometimes for 4 or 5 days and other times for longer. You meet with me to discuss your tax filing requirements, especially your payroll. You tell me that you have engagements coming up in the following states and ask me how to handle the employee withholding.

               State                                      Exempt from Employer Withholding if …

Arizona                                               60 days or less

California                                            exempt if less than $1,500

Delaware                                             no exception

Georgia                                               23 days or less

Hawaii                                                 60 days or less

Idaho                                                   exempt if less than $1,000

Maine                                                  10 days or less

Maryland                                             exempt if less than $5,000

Massachusetts                                     no exception

Ohio                                                    less than $300 in any quarter

Virginia                                               exempt if less than $7,000

Now seriously, how are we to work with this? Remember that payroll may have some very nasty penalties for just minor errors. Do we simply withhold from day one on all employees in all states? That is the safest way to go, but now you are going to have monthly or quarterly reporting to almost every state in the nation. Perhaps the report says “zero”, but it will still take time to prepare and file. You may have additional end of year considerations, such as submitting W-2s to the state. Why not just shut down the account every time, you ask? That likely will save little to no time overall and may create more problems whenever you try to reactivate an account.

This all takes time. It may be my time, it may be your employee’s time, but you will be paying for this time. You can now see the issue. If you ship an employee into Delaware for 1 1/2 days, do they really expect you to withhold, remit and keep reporting to Delaware until the cows come home? Perhaps this made sense years ago when our parents worked at the factory down the street, but it makes no sense today. It is unreasonable to threaten an employer with payroll taxes (and penalties) because they made the mistake of sending an employee into your state for 3 or 4 days. This is not the Lewis and Clark era.

Will this bill pass Congress? My hunch is that no tax bill will pass Congress until the elections are resolved, and then only a tax extender bill passed at the last hour of the last day. This bill will not pass this Congress, but at least the issue is being discussed and highlighted. Perhaps next time and next Congress.

Tarpoff, Payroll Taxes and Responsible Person Penalties

John Tarpoff was the head cattle buyer at Gateway Beef, LLC (Gateway). Gateway was formed in 2003 by Gateway Beef Cooperative and Brach’s Glatt Meat Markets (Glatt). Glatt was owned by Sam Brach (Brach).  The co-op sold cattle to Gateway, which then produced kosher beef for Glatt.

In addition to buying cattle, Tarpoff did the following:

·         Filed Gateway’s articles of incorporation, signing as “organizer’

·         Was a signatory on two Gateway checking accounts

o   When opening the accounts, he presented company resolutions which he signed above lines that said “secretary” or “member.”

·         With the resolutions he could open accounts and withdraw funds

Brach was the wallet and financed Gateway. The bookkeeper, Marsha Caughron (Marsha), handled accounts receivable and payable, payroll, and some sales. She received all the mail, including bills and any notices from the IRS. She would print checks, attach the bills and initially send them to Brach. He would sign some, sometimes not all, and send them back. Brach was pretty strict that nothing could be paid without his permission.

Procedures changed and Tarpoff started signing all Gateway checks from January to May 2004 and most checks after that through July 2004. Once again, he signed nothing without Brach’s permission. Some of the checks he signed were for delinquent 2003 taxes, although he could not easily recognize them as such. He would review invoices to be sure they matched the check, but that was pretty much all. He did not even know whether Gateway had sufficient funds to cash the checks. Remember: he was the head cattle buyer, not the accountant.

Tarpoff explained to the Court:

            Whatever checks were given to me, I would look at them, glance at them and sign them.”

He could not recall ever refusing to write or sign a check.  

Gateway was a shooting star, living a short life and burning through a lot of money. At some point, Brach stopped paying the payroll taxes. The bookkeeper, Marsha, would calculate the taxes, attach checks and send them to Brach. Brach would not sign or return the checks. When she pressed, he told her to speak with his accountant, Michelle Weiss. Brach also instructed Marsha to fax all IRS notices to Michelle. Tarpoff was unaware of these faxes.

Tarpoff wrote at least 10 checks that bounced. One (for approximately $49,000) must have been pretty important, as he tried to get it paid. Meeting with resistance, he paid it out of personal funds. He said this was the only bad check he was aware of. He was never repaid his $49,000 and ultimately had to refinance his home because of it.

Gateway finally folded in July 2004. Tarpoff left. After learning that some vendors had not been paid, he suspected shenanigans with the payroll taxes. He was informed that Brach had not paid the taxes and the bookkeeper (Marsha) told him she had been receiving IRS notices. That was the first he learned of the matter.

The IRS came in. They wanted the payroll taxes. They also wanted almost $67,000 in penalties from Tarpoff for quarters March and June, 2004.

The IRS said that Tarpoff was responsible because:

·         He held himself out as secretary or manager.

·         He attended board of directors meetings.

·         He was the organizer of Gateway Beef, LLC.

·         He could open accounts and withdraw funds.

·         He signed over 1,800 checks.

·         He could hire and fire employees.

·         He could refuse to sign checks.

·         He invested approximately $50,000.

·         He knew the government had not been paid.

·         Even if he did not know the government had not been paid, he could have deduced it. He had paid payroll taxes in the past (at another company), and he signed enough checks to realize that all taxes had not been remitted.

·         The company was losing money; he was in a position to know and review the books and records to be sure taxes were being paid.

·         He used monies to pay creditors ahead of the government

                       

The Court held the following:

·         Other than puffery, the only evidence of officer status was preprinted checks. He did not write any business title himself.

·         He never attended a board of directors meeting.

·         He only looked at the checks and invoices to see that they matched. He could not pay anything without Brach’s permission.

·         He could interview prospective employees and he handled relations with the union, but he could not hire or fire without Brach’s permission.

·         Perhaps he could have refused to write checks, but Brach would have signed instead. Brach had previously signed checks.

·         He did not “invest” $50,000. To the contrary, he had so little control he could not get his own money back.

·         He did not know about the payroll issues and did not receive IRS notices. They went instead to the bookkeeper and then to Brach’s accountant.

·         Saying that he knew in general about an employer’s responsibilities over payroll taxes is not the same as saying he willfully and consciously failed to remit Gateway taxes.

·         There was no evidence he knew the company was losing money, and he did not have authority to look at the company books.

·         He paid creditors ahead of the government because he did not know about the payroll taxes until after he left Gateway.

Tarpoff finally won, but in Court and after much time and expense.

I am curious why the IRS did not go after Brach. From reading the case it seemed quite clear that he had more control than Tarpoff. The IRS thought they saw the fact pattern they like: looks like an officer, makes business decisions, pays bills, writes checks, decides who gets paid, “in the loop” enough to know that the IRS is getting ignored.

From what I see Tarpoff was in a terrible position. He was associated with a money pit, had responsibility but no authority, was intimidated by a boss (Brach), reached into his own wallet (I can only imagine he was preserving his business reputation) and lost the money, and at the end was hounded by the IRS. Frankly, I am cynical about Brach’s behavior in this matter, as I sense that Tarpoff was set-up as a “fall guy.”

If there was a truck or dog or past girlfriend in the story, one could write a country song.

Seriously, be very careful if you have some of the “sexy” fact patterns the IRS likes and you are somehow associated with payroll at a struggling company. The IRS has a track record on this issue. You do not want to run on this track. In some areas you can work with the IRS. This is not one of them.

The IRS refers to it as the “responsible person” penalty.  It applies to failure to remit withheld federal payroll taxes.  You can think of federal withholding taxes as having five pieces, as follows:

·         Federal income tax withheld

·         Social security withheld

·         Medicare withheld

·         Employer match of social security

·         Employer match of Medicare

Here is the concept: the IRS considers the first three to be the employees’ money, which the employer holds in trust. When the employer fails to remit these, it is not only tax noncompliance but also theft. The IRS is very harsh on this issue and will impose one of its harshest penalties: the “responsible person” penalty. This penalty is 100%. Yes, you read that correctly.

You never want to be “responsible” for this purpose. The IRS can chase to ground anyone it considers responsible and assess the penalty. It doesn’t matter whether you own the company, or are an officer, or even still work there. 

Think about the math for a moment. The company falls behind on its payroll taxes. The IRS will proceed against the company for the taxes. If it then chooses to assess penalties, it does so against the responsible person. That penalty is 100%. The company pays. The responsible person pays. The IRS is paid twice.

Let’ go over a quick example: Let’s say that the amounts are as follows:

·         Federal income tax                 $1,800

·         Social security withheld         $   336

·         Medicare withheld                 $   116

·         Employer social security        $   496

·         Employer Medicare                $   116

When the IRS goes against the company, it will want a check for $2,864 ($1,800 + 336 + 116 + 496 + 116).

NOTE: The employer social security is higher than the employee withholding because of the 2-point reduction in employee social security for 2012.  The employer percentage remained at 6.2% whereas the employee share was reduced to 4.2%.  This was part of the effort to stimulate (or at least not de-stimulate) the economy. It is also slated to expire at the end of 2012.

If the IRS assesses the responsible person, that penalty will be $2,252 ($ 1,800 + 336 + 116). Notice that the employer share doesn’t count for purposes of this penalty. Small consolation.

There are two major tests that the IRS will consider to determine if someone will be charged with the “responsible person” penalty:

(1)   Did the person have a responsibility to collect, account for and pay the trust fund taxes; and

(2)   Did the person willfully fail to perform this duty?

Let’s break down the first test. What if you are a payroll manager, responsible for running payroll and correctly accounting for withholding taxes? Are you responsible? No, not by itself, because you do not have authority to pay bills and write checks. What if you are the treasurer, with authority to write checks? Are you responsible? You will have the IRS’ attention, but the technical answer is no, not by itself. In our next blog we will discuss a taxpayer who wrote over 1,800 checks but argued that he was not a responsible person. The IRS did not believe him, of course, so off they went to court.

On to the second test. We are presently representing a responsible person client on the issue of willfulness. Willful means that one voluntarily and intentionally paid, or continued to pay, other creditors while knowing that the company failed to pay over withheld funds to the government. The IRS in the past has argued that payments to a creditor – mind you, any payments to any creditor – could be sufficient to show willfulness.

Fortunately the courts have slowed down the IRS. Let’s say the check writer was unaware of the lapsed payroll deposits, for example. How? One way is lack of financial sophistication. What if the bookkeeper “took care of it,” and the bookkeeper suddenly took ill, became disabled or left town? The business owner or manager could well need time to ramp-up, whether that means payroll, using QuickBooks or any other duty previously performed by the bookkeeper. Can one say there is “willful” intent while the owner or manager is struggling through the learning curve? Let’s swing the other way and say the check writer was financially sophisticated. What is your opinion if told that the check writer wrote checks only infrequently, and that when the primary signor was on vacation or otherwise unavailable? What if the check writer was unaware of any payroll problems? What if the check writer is authorized pay to vendor payables but excluded from any payroll responsibilities? What if the check writer was intimidated by his/her boss?

This area is of concern because of the poor economy in the last several years. There is great temptation to consider payroll taxes as yet another funding source, reasoning that the IRS can wait like any other creditor. That is not true. The IRS is not just any other creditor. The IRS can assess and collect tax for 10 years past the assessment date, and longer than that if it reduces the assessment to a judgment. And do not assume this is automatically dischargeable in bankruptcy court.  This is called “expensive money.”

Next blog: we will talk about Tarpoff and his responsible person penalty.

Form 1099-K Reconciliation Cancelled

The IRS has decided that businesses will not be required to reconcile their gross receipts with merchant card transactions reported on the new 1099-K form.

Steven T. Miller, IRS deputy commissioner for services and enforcement, wrote to the National Federation of Independent Business that no reconciliation will be required on 2012 or future business tax returns. Last October the IRS had earlier said that no reconciliation would be required for only the 2011 tax returns.

In the way of history, the Housing and Economic Recovery Act of 2008 required the IRS to begin collecting a new Form 1099-K from payment-settlement entities, such as credit card companies, for merchant transactions such as credit and debit card payments. The payment settlement entity is required to issue a 1099-K to a merchant if the merchant’s business for the previous year exceeded either $20,000 or 200 transactions.

Why would businesses complain? Well, for one, if the taxpayer identification number and legal name do not match with IRS’s files, there is back-up withholding of 28% of the transaction. How is the business to account for refunds or returns? For sales taxes? How is the 1099-K to be reconciled with accounting systems which are geared to track sales by product or type, not by payment type? How will one account for fiscal years, when the 1099-K’s will all be on a calendar year? And who is going to pay for the accountant to reconcile all this nonsense?

Rental of U.S. Real Estate by a Nonresident

I was speaking with someone from overseas about buying real estate around here and renting it out. This person is a green card holder, so their tax considerations in owing rental real estate would be the same as yours or mine.

But what if they were not a green card holder?

Different set of rules. We are talking about the U.S. taxation of a nonresident alien. A nonresident alien does not have a green card or spend enough time in the U.S. to be considered a resident.

There are two ways to handle a nonresident alien’s reporting of U.S. rental real estate.

Let’s call the first one the “default” rule. This type of income is referred to as “fixed, determinable, annual or periodic” (FDAP) and carries a 30% tax rate on the gross amount of income. Examples of FDAP are interest, dividends, annuities, royalties and rents. 

Let’s use some numbers to make this concrete:

                        Rent received                                                24,000

                        Property management                                    2,400

                        Real estate taxes                                            6,000

                        Insurance                                                        1,600

                        Depreciation                                                   9,000

                        Net profit                                                        5,000

Oh, the property manager will have to withhold the 30% upfront. The manager has to, as the tax code requires the manager to pay the 30% from his/her own funds if he/she does not withhold it from you.

Under the default rule the property manager will withhold 30% of your rental income, or $7,200, and forward it to Treasury. At the end of the year the manager will send you a Form 1042-S reporting the withholding. The good news is that you do not have to file further taxes. The bad news is that it cost you 30%.

NOTE:  The 30% is not cast in stone. It can be overridden by treaty.

The second way is to make an election, so let’s call it the “election” rule. The idea here is that you have a trade or business in the United States (you do, sort of, as a landlord), and you are going to elect to have the rental property “effectively connected” to your business. The principal tax difference is that you will owe tax using graduated tax rates on your net rental income. To phrase it another way, “effectively connected income” (ECI) of a foreign person is taxed like the income of a U.S. person.

The first thing you do is file a form (Form W-8ECI) with the property manager so the manager does not have to withhold 30% from you.

The second thing you have to do is file a tax return (Form 1040NR) at the end of the year. You have to include an election in the return alerting the IRS what you are up to. You will pay tax on $5,000, which is big improvement over paying tax on $24,000. Technically, you would be paying tax on less than $5,000, as you also get a personal exemption, but you get the idea. You also have graduated tax rates – not a flat 30% like under the default rule.

By the way, if you came into our offices using the default rule, we would likely encourage you to file a return anyway under the election rule. Why? To get back some of your 30% withholding, that’s why. The government would have gotten $7,200 from you. That was more than your profit before giving the government anything! Then we would have you fill out the paperwork to have the property manager stop withholding on your rent checks.

The IRS Is Selling a Super Bowl Ring

I am a huge NFL fan. It is, without a doubt, my favorite sport.

Did you hear about Fuzzy Thurston’s tax problems?

Who is Fuzzy? His actual name is Fred Thurston. He played with the Green Packers from 1959 to 1967. He played guard in the first two Super Bowls under Vince Lombardi.

He was considered a tough football player and part of the famed “Power Sweep.” When asked how he prepared for the bitter cold of the Ice Bowl on December 31, 1966 at Lambeau Field against the Dallas Cowboys, he replied “About 10 vodkas.”

After football he became a restaurateur. He and partners, including Max McGee, opened a restaurant named Left Guard in Menasha, Wisconsin and eventually had six locations throughout Wisconsin. Fuzzy played left guard – hence the name of the restaurant.

The trouble arose with employment taxes. Somewhere between 1978 and 1980 the Janesville restaurant failed to remit payroll taxes withheld from employees. We have spoken of withholding before. These penalties are some of the toughest in the IRS arsenal. It makes sense, if you remember that these are withheld taxes. The money belongs to the employees, and the employer is merely a conduit for remittance to the Treasury. When the employer fails to remit, it not only deprives the Treasury but it has also robbed from its employees.

So Fuzzy had a withholding problem. The tax action goes against the company and the responsible persons at the company. As a partner, Fuzzy must have had enough authority to be considered a responsible person. So were his partners. His partners paid-off their actions, but Fuzzy fought his. The initial judgment against him in 1984 was approximately $190,000.

Fuzzy continued to fight. His liability, with interest and penalties for more than 25 years, is a little more than $1.7 million. The IRS is selling off his football paraphernalia, including his 1960 Packers helmet, two 1960 footballs signed by Packers players and Vince Lombardi, his NFL championship rings from 1958, 1961, 1962 and 1965,  and Fuzzy’s Super Bowl II ring. The IRS is searching for his Super Bowl I ring also, but it hasn’t turned up.

It’s an unfortunate story, but I have to point out that Fuzzy either dug in his heels unreasonably or otherwise received horrendous tax advice. Perhaps he felt that his partners stole from him and that he wasn’t responsible. Fine, but a quick education from his accountant might have included the concept of surrogate liability, and that as a partner in the restaurant he had triggered that liability. At that point it was not a matter of right or wrong, but rather a matter of emergency room decision-making. Stop the bleed, clot the wound, stabilize the patient, live to fight another day. I have to believe he could have come up with $190,000 in 1984. He could then have sued his partners, if it made him feel better. But he was not going to win the responsible person action against him with the IRS.

The Mobile Workforce State Income Tax Simplification Act of 2011

Kudos to US Representative Hank Johnson (GA) for cosponsoring the Mobile Workforce State Income Tax Simplification Act of 2011. This bill was proposed in a previous session of Congress. At the end of each session, all bills and resolutions that haven’t passed are cleared. Rep Johnson has reintroduced the bill with Rep Coble (NC).

The concept is simple: if an employer sends employees temporarily across state lines, the employer will not have to register with and withhold taxes for the other state. Temporary is defined as 30 days or less.

Rep Johnson comments:

The tax system is already too burdensome and complicated as it is. This simplifies the code and would prevent Americans who work in multiple jurisdictions from being taxed by state and local governments other than the places in which they live or perform duties over an extended period.”

The hearing was May 25, 2011 before the Subcommittee on Courts, Commercial and Administrative Law.

As someone who has had to worry about this very same issue, I am pleased that someone up in Washington “gets it.”

Perhaps they should include sales taxes and also call in bureaucrats from Texas to explain their position on trade shows. Consider this gem. The Texas Comptroller determined that an out-of-state seller of dental equipment was required to collect sales taxes because it attended an annual trade show in Texas. Mind you, the orders were filled, shipped and billed from outside Texas, but the company did send a person to attend that trade show. Yipes!