Recent Developments in Employment Tax / Compensation and Benefits

June 10, 2015

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Disclaimer

► This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide tax advice to any taxpayer because it does not take into account any specific taxpayer’s facts and circumstances.

► The views expressed by the presenters are not necessarily those ofErnst & Young LLP.

► This presentation is © 2015 Ernst & Young LLP. All Rights Reserved.

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Today’s agenda

► Short-term business traveler income tax considerations► Worker classification► IRS audits ► Additional Medicare Tax► Non-qualified deferred compensation plans ► 162(m) final regulations

Short-term business travelers

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Multistate income tax withholding Trailing compensation

Employee is relocated to

Nevada as of time of payment

Earned in New York

► In many states, lump sum payments such as accrued paid time off, severance, equity compensation and nonqualified deferred compensation must be sourced to the state(s) where the compensation was earned for income tax withholding purposes

► An exception applies to qualified retirement and to top heavy plans (Supplemental Executive Retirement Plan (SERP) or nonqualified deferred compensation) that are paid in substantially equal periodic payments over a period of not less than ten years (P.L. 86-272)

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Telecommuter considerations

Double taxation under “convenience of the employer” rule► New York takes the position that 100%

of the wages paid to a nonresident are subject to New York income tax if the employee is working out of state for the employee’s own convenience

► The rule applies when an employee receives direction and control from a New York location

► To argue that work location is for the employer’s convenience, there must be a direct business benefit in having the employee work outside of New York

► The rule can result in double taxation (tax in both the resident state and New York)

Working from home

► If employees regularly work from home, the home office could be treated as a work location of the employer in many states (and localities)

► If the home office is deemed an employer work location, income tax withholding, unemployment insurance and other businesses taxes can trigger

► In a New Jersey case, it was determined that a foreign corporation with a principal place of business in Maryland was subject to New Jersey’s corporate income tax requirements because one of its employees was allowed to work on a full-time basis from her New Jersey home office(Telebright Corporation v. Director, N.J. Super. Ct.

App. Div., Dkt. No. A-5096-09T2, 03/02/2012)

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Managing short-term business traveler risk

Assign ownership

Developpolicy

Secure technology,

establish process

Monitor and govern

Compliance

Quantify exposure

• Undertake a risk assessment• Identify at risk population• Set policy parameters • Start a pilot program• Segment your

implementation• Monitor

performance

Loss

of r

eput

atio

n Tax, penalty, interest

Seizure of assets

Employee morale

Risks

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FYI: US domestic mobility tax

► Alabama. Proposed rule would change employer due date from February 28 to January 31 effective for tax year 2015

► Nebraska. Effective for tax year 2014, employee copies are due February 1 rather than February 15

► Wisconsin. Effective for tax year 2015, the Department of Revenue will return any Form W-2 files that don’t meet its requirements

► Virginia. Due date for electronically filing Form VA-6 and Forms W-2 with is changed to January 31 effective with tax year 2014. More information is available here

► Indiana: The Indiana Department of Revenue ruled that a bonus earned in the state but paid to an employee who subsequently moved to another state is subject to state income tax withholding but not county income tax withholding (Indiana Revenue Ruling 2014-02, 1 October 2014).

► Virginia: The Virginia Tax Commissioner ruled that wages earned by a Virginia resident working from home are sourced to Virginia for income tax and withholding purposes even though the employer has no other business office within the state. (Ruling of the Virginia Tax Commissioner, Document No. 14-158, 28 August 2014).

One of the most challenging areas of employment tax compliance is the interaction of the wage tax rules when employees work and reside across multiple jurisdictions during the wage payment life cycle.

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• Investigative teams are focused on transient out-of-state vendors with business activities in New Jersey that create “nexus” thereby triggering an obligation to register with the New Jersey Division of Taxation

• For instance, the Division and the New Jersey State Police teamed to focus on truck stops in order to identify if out-of-state businesses were properly registered to do business in the state

• The Division recovered nearly $1.2 million in back taxes from unregistered companies during fiscal year 2014

New Jersey nonresident audits

New Jersey’s efforts highlight a growing interest by a number of states to focus on uncollected revenues from the mobile workforce. Domestic mobility tax is a significant compliance concern of businesses today.

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Mobile Workforce State Income Tax Simplification Act of 2015 (HR 2315/S 386)► The legislation has been introduced in both the House and Senate and referred to

Committee (Judiciary and Finance, respectively) ► The bill would limit nonresident income tax only to:

► The state of the employee’s residence; and► The state within which the employee is present and performing employment duties for

more than 30 days during the calendar year in which the wages or other remuneration is earned

► In determining nonresident income tax, an employer may rely on an employee’s annual determination of the time expected to be spent in the nonresident state(s)

► An employee would be considered present and performing employment duties within a state for a day if the employee performs more of the employee’s employment duties within such state than in any other state during a day► If an employee performs employment duties in a resident state and in only one

nonresident state during one day, such employee shall be considered to have performed more of the employee’s employment duties in the nonresident state than in the resident state for such day

► The bill faces strong opposition from certain states as well as the Federation of Tax Administrators and the National Governors Association

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Worker classification

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Worker classification The IRS common-law (20-question) test

1. Receives work instructions 11. Must provide oral or written reports

2. Receives training 12. Paid by the hour, week, month

3. Provides services that are integral to the line of business

13. Doesn’t pay business and/or travel expenses

4. Must render services personally 14. Doesn’t furnishes tools and materials

5. Doesn’t hire, supervise or pay assistants 15. Has no opportunity for profit or loss

6. Has a continuing relationship with the business 16. Makes no significant investment

7. Doesn’t set hours of work 17. Doesn’t work for more than one firm at a time

8. Must do work on customer’s premises 18. Can’t make services available to others

9. Doesn’t set order or sequence of work 19. Has no right to hire employees

10. Is required to work full time 20. Has no right to terminate employees

The worker is likely a common law employee, and not an independent contractor under Rev. Rul. 87-41 if he or she:

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Worker classification rulings in 2014

• California: The Ninth Circuit, reversing the Multidistrict Litigation Court’s grant of summary judgment for FedEx, has held that under California law FedEx drivers are employees, not independent contractors (Dean Alexander, et al. v FedEx Ground Package System; 27 August 2014)

• Kansas: The Kansas Supreme Court held that FedEx’s full-time drivers are employees and not independent contractors under the Kansas Wage Payment Act (FedEx Ground Package System, Inc. No. 108,526; 3 October 2014)

• Oregon: The Oregon Court of Appeals, on4 September 2014, held that taxi cab drivers under contract with Broadway Cab LLC were employees, not independent contractors, and their compensation, therefore, was subject to unemployment insurance tax (Broadway Cab LLC v. Employment Department; 4 September 2014)

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Worker classification enforcement trends in 2014

• Pennsylvania: Senate Bill 1454 would authorize Pennsylvania district attorneys to prosecute violations of the law (including jail time) governing the classification of workers and reimburse counties for their enforcement expense. Enforcement remedies include jail time for violators

• Kentucky: In its September 2014 online newsletter, the Kentucky Labor Cabinet states that wage theft is more than double all robberies in the state warranting enforcement efforts that include collecting $4.5 million in wage restitution from employers each year for an average of 12,200 Kentucky workers. Wage theft includes misclassifying workers as independent contractors

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US Department of Labor is funding state worker classification audits

$2 million Awards for demonstrating a high level of performance or significant improvement in detecting and prosecutingemployers that fail to pay their fair share of taxes due to worker misclassification

State grants are available to: • Improve systems that will

enable sharing and analysis of data from federal and state agencies that will enhance identifying employers more likely to misclassify employees

• Implement targeted audit strategies to focus on those employers most likely to misclassify workers

• Establish a statewide task force to target egregious worker misclassification schemes

• Develop education and outreach programs for employers to help prevent worker misclassification.

$8 millionCompetitive grants to increase capacity for preventing and detecting worker misclassification and enforcing state UI laws and policies

FY 2014 funding for state unemployment workerclassification enforcement

For more details see Ernst & Young LLP’s special report here.

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Worker classificationAffordable Care Act considerations ► Employer mandate: Code Section 4980H mandates that applicable large

employers offer coverage to all full-time employees, and that such coverage be affordable and provide minimum value.

► Code Section 4980H and the associated regulations define “employee” as an individual who is an employee under the common-law standard:

► Analytical Test: IRS Three-Factor Test ► Behavioral control► Financial control► Relationship of the parties

► Legal Test: Is there a right to direct and control the means and details of the work being performed

► If an employer does not offer minimum essential coverage to “substantially all” of its full-time employees, the employer will be subject to a penalty under Code Section 4980H(a).► “Substantially all” means:

► 70% of employees in 2015► 95% of employees in 2016 and beyond

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Worker classificationAffordable Care Act considerations

Misclassified contingent workers may expose an employer to penalty taxes

10,000 full-time employees + 2,000 misclassified contingent workers = 12,000 total employees

could be subject up to a $24m penalty tax

4980H(a) example ► Company A has:

► 10,000 full-time employees that are issued W-2s, all of whom receive an offer of minimum essential coverage.

► A significant contingent workforce of 5,000 non-W-2 workers providing services, none of whom receive an offer of coverage from either Company A or any other entity.

► After an analysis, it is determined that 2,000 contingent workers were misclassified and were actually common-law employees of Company A.

► 10,000 offered coverage out of 12,000 total full-time employees (83.3% offered coverage)

► In 2016 and beyond, this would generate a penalty of $24m (12,000 employees multiplied by $2,000 per employee)

IRS audits

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► From 2010-2013, the IRS conducted detailed employment tax examinationsas part of a national research program(NRP)

►A NRP collects data that helps the IRS improve compliance programs and make better use of its resources

►In each of the three years, a target of 2,000 examinations was planned

►Primary focus was worker classification, fringe benefits, officers' compensation, and reimbursed expenses

►Results have not yet been published but IRS has indicated concern in three areas

IRS National Research Program (NRP) Focused employment tax audits

Background

Company meals and cafeterias

Gift cards

IRS

are

as o

f con

cern

Travel and meetings

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► Paid vacations and “staycations”► Spousal/dependent travel► Wealth management services (other than

qualified retirement planning)► Personal use of company jet► Personal use of company car► Security-related transportation► Chauffeurs and private car service► Travel and living expenses where job

assignment is more than one year► Relocation reimbursements ► Late tax deposits on noncash fringes (in

particular, stock transactions) ► Athletic and other sky boxes ► Transfer of property ► Use of Form 1099 vs Form W-2 for

reporting directors’ compensation ► Reduction in taxable compensation for

charitable contributions

IRS ongoing audits Executive compensation

Compliance risks

Areas of interest

Tax, penalty, interest

Officer personal liability

Loss of government contracts

Loss

of r

eput

atio

n State/local information sharing

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IRS ongoing audits 409A compliance initiative

Focus► Targeted group of approximately 50 large companies (selected from a group of

companies previously identified for employment tax audit) ► Limited duration project► Focus on the top 10 most highly compensated employees.

Purpose► To understand the level of Section 409A compliance or noncompliance► Evaluate audit techniques, and determine whether the information document

requests (IDRs) that the IRS has developed are effective in getting the relevant information necessary to test compliance

Scope of review► Initial deferral elections► Subsequent deferral elections► Distributions and payments, including whether payments:

► comply with the strict payment timing rules (e.g., only upon a fixed date, separation from service, etc.), and

► are in compliance with the six-month delay requirements for specified employees

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A day in the life of employee stock options Timely reporting and deposits

Federal, state and local tax examiners are focused on employee stock options, in particular, whether the withholding, employment tax and reporting occur on time. Late deposit penalties and interest can be significant.

TuesdayJune 2

Tax deposit due date for noncompliant employer audit

FridayJune 5

Extended federal due date (3 days for stock trade) under IRS field service advice

MondayJune 1

Stock option exercised and employer is one-day tax depositor

►Monday June 1

FridayJuly 31

Report wages and taxes on 2nd quarter Form 941

►Friday July 31

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Additional Medicare Tax

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Two Medicare surcharge taxes apply

► Applies to earned income (wages)► Employers withhold on wages in excess

of $200,000 ► There is no employer contribution ► This tax is in addition to the 1.45%

Medicare tax employees already pay (and that employers match)

Net investment income tax (NIIT) of 3.8% (not a payroll tax)► Applies to unearned income in these

categories: ► Interest, dividends, rents and annuities

not derived in the ordinary course of a trade or business

► Trade or business income from passive activities or from trading in financial instruments or commodities

► Net gains from the disposition of property not used in a trade or business

Additional Medicare tax of 0.9%

Both the 0.9% additional Medicare tax and the NIIT apply to covered earnings in excess of $125,000 for married filing separately, $200,000 for single filers and $250,000 for joint filers

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6 key Additional Medicare Tax facts

4 You aren’t automatically required to pay withholding shortages to the IRS. (Use Form 4669 to eliminate liability)

5Additional Medicare Tax paid on behalf of employees is taxable.

6When employees repay prior-year wages, you can’t refund the Additional Medicare Tax you withheld.

1 IRS information resources concerning the Additional Medicare Tax are available here.

2 You can’t withhold more or less than 0.9% on wages in excess of $200,000.

3 You can’t refund excess Additional Medicare Tax withholding for the prior year.

For more information on the Additional Medicare tax read here.

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Additional Medicare Tax considerations

► Remind employees that what you withhold could be too high or too low; Form W-4 can be revised accordingly

Employee communications

► Consider capturing the Additional Medicare Tax withheld in Form W-2, box 14

► Also consider showing Medicare and Additional Medicare Tax (show “Med surcharge” withholding on the employee pay stub)

Recordkeeping

► Include the Additional Medicare Tax in gross-up calculations and consider the budgetary impact

► Consider revising wage repayment agreements to include the fact that the employer cannot refund withholding of the Additional Medicare Tax in subsequent calendar year

Gross-up and wage repayments

Non-qualified deferred compensation plans

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Non-qualified deferred compensation (NQDC)Potential employee litigation risk

FICA/Additional Medicare tax ► At time of vesting (special timing rule)► Increase/decrease in

balance not taken into account after vesting (nonduplication rule)

► If not taxed at vesting, taxableon balance in each year of distribution

Federal income tax ► At time of distribution ► Report in Form W-2, box 11

amounts in Boxes 1 or 3earned in a prior year

Correcting FICA timing errors ► Special timing rule may be retroactively

applied for the statute of limitations (3 years)► Beyond the statute of limitations, special timing

rule no longer available and FICA is computed on ending balance in each year of distribution

► When computed in year of distribution, taxable up to the Social Security wage base in the year of distribution vs. special timing rule where NQDC likely only subject to Medicare tax

Employee litigation for employer failure to use FICA special timing rule

► Employees could pay more FICA and Additional Medicare tax due to employer’s failure to include NQDC in wages in year of vesting

► A federal district court ruled in 2015 that employer was liable for damages becauseof increased FICA taxes employee paid due to employer’s failure to use special timing rule[Davidson v. Henkel Corporation, DC MI, 115 AFTR 2d 2015-369, 1/6/15]

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Non-qualified deferred compensation (NQDC)Davidson v. Henkel Corp.

Background► Action to recover benefits under a NQDC plan that were wrongfully reduced as a result of the

employer’s failure to comply with the special timing rule► NQDC plan provided:

► The Company or its authorized representative shall have the right to withhold any and all local, state, and federal taxes that may be withheld from any distribution in accordance with applicable law. In addition, if a Participant’s interest in the Plan becomes subject to local, state, or federal tax before distribution is made, the Company or its authorized representative shall the right to withhold such taxes from the Participant’s Base Salary.

► For each Plan year in which a Deferral is being withheld or a Match is credited to a Participant's Account, the company shall ratably withhold from that portion of the Participant's compensation that is not being deferred the Participant's share of all applicable Federal, state or local taxes. If necessary, the Committee may reduce a Participant's Deferral in order to comply with this Section.

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Non-qualified deferred compensation (NQDC)Davidson v. Henkel Corp.

Ruling► The court rejected Henkel’s argument that the special timing rule is elective under its NQDC

plan based on the following:► Although nothing in the Code mandates the use of the special timing rule, the plan

explicitly required the company to properly withhold the taxes when they were assessable or due.

► A main purpose of the NQDC plan is to allow tax savings including savings under the special timing and non-duplication rules.

► In a letter to participants, the employer admitted that it had made a mistake in not withholding FICA taxes.

Implications► Plan provisions related to tax withholding may create potential liability independent of statutory

withholding requirements.► Employee communications should be carefully crafted.► Plan administration and payroll administration should be coordinated.

162(m) final regulations

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162(m) final regulations

Individual share limit► An aggregate limit does not satisfy the

performance-based compensation requirements.

► Applies to compensation attributable to stock options and stock appreciation rights that are granted on or after June 24, 2011.

Application of transition rule to RSUs► Under the private-to-public exemption,

the date of grant rule does not apply to RSUs and other phantom equity interests.

► Applies to RSUs granted on or after March 31, 2015.

162(m) final regulations settle two key issues:► Whether an individual share limit is necessary for equity compensation to be considered qualified

performance-based compensation under Section 162(m)► How the IPO transition rule applies to restricted stock units (“RSUs”) and certain other equity

compensation

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Comments? Questions?

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