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Cash-Starved States Step Up Pursuit Of Nonresident Tax Revenue

Wayne K. Berkowitz, CPA, J.D., LL.M. 02.02.2011 | Practice Made Perfect

Lean times are compelling states to be more sophisticated in their quest to find nonresidents performing services within the state and not paying the corresponding tax. Individual partners who don’t even set foot in a particular state may still owe nonresident tax in their roles as partners in a firm doing business there. Firms may trigger filing and withholding obligations simply by sending an employee or a partner into a state. With enforcement on the rise, there are steps that give firms more protection.

Nonresident tax exposure exists mainly on two levels; income tax withholding for employees and income tax filings and liabilities for the partnership and its partners. Use your time and billing systems to keep track of where work is performed. Armed with this information, you can make an educated decision about where and when withholding should occur and whether to file any other returns. Once a decision to withhold and file in a particular state is made, the time and billing information will help you properly report the amount of income to the jurisdiction in question.

A few states have set de minimis activity thresholds before taxation kicks in. However, without precise information, it’s surprisingly difficult to substantiate how much or how little time was spent in a particular jurisdiction. Penalties for failing to withhold from employee wages are some of the most punitive. Further, by properly substantiating where work was performed, you can more effectively apportion earnings and help ensure that the proper tax is paid to each jurisdiction.

Another way to protect yourself is to centralize the way you calculate estimated tax for the firm and each individual partner’s nonresident tax liabilities by using composite returns.