Mobility: It s Not Just a Global Discussion

SESSION 3.5 Mobility: It s Not Just a Global Discussion Kate Forsyth Peter Simeonidis Senior Manager Senior Manager Deloitte Tax LLP Deloitte Tax LLP 213-593-4279 212-436-3092

SESSION 3.5 Mobility: It s Not Just a Global Discussion Kate Forsyth Peter Simeonidis Senior Manager Senior Manager Deloitte Tax LLP Deloitte Tax LLP 213-593-4279 212-436-3092 Agenda Introduction What are the domestic issues? Timing of taxation Sourcing/apportionment Employer tax withholding requirements Double tax issues Approaches to determining withholding/reporting obligations How to track individuals? Practical guidelines

What are the Domestic Issues? What are the Domestic Issues? Individuals traveling for periods of varying lengths between multiple states can create state income tax issues (just as travel between countries can create tax compliance issues) Companies need to understand Who are these individuals? How to track the movements? How to determine what needs to be reported to a particular state and the amount of income that may be sourced to an nonresident state? How to determine what withholding obligations apply? Are there any nuances that lead to a reduction of withholding (reciprocity/state tax credits)?

Which Individuals are Impacted? Groups of Impacted Individuals Employees that work in one state in which the services are performed but reside in another state Long-term or short-term domestic assignees Permanent domestic transfers Frequent business travelers Project based employees/consultants Former employees that retire to another state Why is this an Issue Now? Withholding tax has now been designated as a Tier 1 issue by the IRS (withholding tax is now a mandatory audit item in all Large & Mid-Size Business audits) so this area has a lot more visibility Increased scrutiny and visibility in states regarding equity incentives States are enacting legislation regarding taxation equity incentives for nonresidents (e.g., Minnesota, New York) Increased scrutiny with respect to accurate tax withholding and reporting Payroll tax audits and notices by a number of states

Individual Tax Treatment Timing of Taxation Many states follow the federal income tax treatment of equity awards: Nonqualified stock options (NQSO) subject to tax on the "spread" at exercise Restricted stock (RS) subject to tax at vesting Restricted stock where Section 83b election made tax at grant Restricted stock units (RSUs) subject to tax at distribution Incentive stock options (ISOs) subject to tax at sale Internal Revenue Code 423 Employee share purchase plan (ESPP) subject to tax at sale Non-qualified ESPP subject to tax at purchase Different State Treatments Pennsylvania taxes ISOs in the same manner as NQSOs. PA also taxes ESPP income at purchase (Fair market value at purchase less purchase price) Special rules (preferential treatment) Hawaii Exemption from income for stock option income received from a Qualified High Technology Business ("QHTB") ( 235-9.5) Rhode Island Exclusion for stock options granted by a qualifying Rhode Island corporation to Rhode Island resident employees ( 44-43-8)

State Taxation of Residents and Nonresidents Generally residents are taxed on all income in their respective state regardless of its source with some exceptions State determination of residency when is someone considered a resident or nonresident? What factors are considered in breaking state residency? Generally nonresidents are taxed on income from sources within the state: City or local tax may also be due on equity income Tax treatment will differ based upon locale and how locale taxes residents and nonresidents Have you reported the nonresident state income where employee worked in a US state before beginning an overseas assignment? Work State Versus Residency State Employees that work in one state in which the services are performed but reside in another state e.g., employee lives in Connecticut but works in New York. 100% of the award is sourced to NY based on work days, however, 100% is taxable to the employee as a resident in Connecticut Complication: Employees may perform services in more than one state besides resident state and primary work state e.g., Employee lives in New York, works partly in Connecticut and New York, also has work days in Massachusetts and New Jersey and worked on a project in Michigan

Sourcing/Apportionment Sourcing must be considered on a state-by-state basis and will depend on a number of factors including: Type of equity award Residency resident versus nonresident Is there state specific legislation, case law or rulings? Generally compensation income is sourced to a state to the extent that the income is attributable to services performed in the state. Determination of the appropriate sourcing period - Grant to vest - Grant to exercise - Year of grant - Last 5 years of employee service Sourcing/Apportionment State Sourcing Methodologies State Sourcing of Stock Option Income for Nonresidents Arizona - nonresidents: Source grant to exercise (AZ ITR 02-05) Connecticut: Allocation based on compensation for services performed in CT during the allocation period by the total compensation received during the allocation period. Allocation period is January 1st year of grant through December 31st year of exercise (CT Reg. 12-711(b)-18) Illinois: Treated as compensation for past services, general rule, presumed to be earned ratably over the last five years of service with the employer (IL Reg. 100.3120, IT 05-0023 GIL) New York: Grant to vest (NY Reg. 132.24) Virginia: NQSO - Grant to exercise. ISO income not taxable for NR if employee was not a VA resident at least two years prior to sale of the stock (VA Ruling of Commissioner, P.D. 05-32)

Sourcing/Apportionment State Sourcing Methodologies State Sourcing of Stock Option Income for Nonresidents Oregon if taxpayer worked in OR in the year the option was granted, source over the grant to exercise period (Reg 150-316.127-(A) ) Ohio nonresidents subject to OH tax on the OH-related appreciation (IT 1996-01) OH income = value of unexercised stock portion at departure value of unexercised stock option at grant Where option granted prior to either moving to or working in OH OH appreciation = value of unexercised stock option at departure value when taxpayer first become a resident of OH or began working in OH Many states have not specifically addressed how nonresident stock option compensation income is taxed or sourced Sourcing/Apportionment Differences in allocation methods among states may result in the same income being taxed in more than one state Example: Employee granted stock option award on March 15, 2009 while working and residing in Connecticut. Stock options vest 100% after 3 years Employee moves to Massachusetts on January 15, 2010 Employee relocates to Texas on March 15, 2011 Employee moves to California on January 15, 2012 where he continues to reside until exercise Over the vesting period the employee has numerous business trips and work days in New York Employee exercises on March 15, 2013

Employer Tax Withholding Requirements Key Question Determine whether employer is subject to withholding rules in a state and if so, on what income and at what rate? Whether there is a withholding obligation depends on the particular state however generally employers will have a withholding obligation at least on income sourced to that particular state. Keep in mind there may be state withholding obligations even where there may be no federal withholding obligation (i.e., where income tax treaty used or individual overseas and utilizing an exclusion from federal income tax withholding such as subject to foreign mandatory withholding or claiming the foreign earned income exclusion). Employer Tax Withholding Requirements Determination of appropriate state tax withholding rates: Paragraph 35 of FAS 123R states that if the number of shares withheld exceeds the number of shares needed to meet the minimum statutory withholding rate, the entire award shall be classified as a liability What is the state minimum statutory withholding rate? Is there a state supplemental withholding rate? Where state has no supplemental withholding rate should the employee s marginal rate be used? What if there are multiple state moves? Is there a local tax rate? What is the current year rate? New York State supplemental withholding rate now 11.03% effective May 1, 2009 (even though actual tax rate lower) California supplemental withholding rate now 10.23% (the maximum rate for individuals is 9.55%)

Double Taxation Issues Tax Credits In the case tax is triggered in multiple states, a tax credit may be available in order to relieve any potential double taxation either through resident state tax credits or nonresident state tax credits (reverse credits) Reverse credit allows employee to take a credit for taxes due to his/her residence state against taxes due in his/her nonresident state (state where services were performed) Both states must allow use of reverse credit Examples of state that allow a reverse credit - California: nonresident reverse credit allowed for residents of Arizona, Indiana, Oregon, Virginia Note - states generally limit credit amount to the amount of tax otherwise due on the income in that state. (The overall income tax payable on the income will be at the higher of the 2 state rates) Double Taxation Issues Tax Credits Resident state may also allow a credit for foreign taxes (FTC) Credit may be limited to certain taxes (e.g., taxes paid in Puerto Rico, or Canada, taxes paid to an overseas region or province) Some states will allow a FTC to the extent the taxes were not claimed on the federal return Some states allow only a foreign tax deduction (where foreign taxes claimed as itemized deduction on federal income tax return)

Double Taxation Issues Tax Credits Example: Employee granted stock option for 100 shares with an exercise price of $5 on May 1, 2008 Employee is a resident of Colorado (CO) at grant On May 1, 2010, employee moves to North Carolina (NC) On May 1, 2011, employee exercises his stock option with a FMV of $20 As a nonresident of CO, employee must report the CO source portion. 100% is reportable to NC where employee is a NC tax resident. Employee claims a tax credit on his NC return for taxes paid to CO. Double Taxation Issues Reciprocity Some states have reciprocal agreements with other states to prevent double taxation Employees who reside in one state but work in another state under reciprocity agreement the employee is only taxed in his/her resident state based on income earned in the nonresident state as a result of his/her employment e.g., Kentucky, Michigan, Ohio, Pennsylvania, and Wisconsin have reciprocal agreements with Indiana (45 IAC 3.1-1-76)

Double Taxation Issues Reciprocity Example: Employee granted stock option for 100 shares with an exercise price of $5 on May 1, 2008. Employee is a resident of Indiana (IN) at grant. On May 1, 2010, employee moves to Pennsylvania (PA), but works in New Jersey (NJ). On May 1, 2011, employee exercises his stock option with a FMV of $20. PA has reciprocity with both IN and NJ. Therefore employees files a PA resident return reporting the IN and NJ source income. Approaches to Determining Withholding/ Reporting 1. Preparation of State Tax Grids Grids prepared with state information upfront which company can refer to at the time of a taxable event covering the following areas: Timing of taxation Allocation calculation Minimum filing threshold State supplemental withholding rate State tax credits/reciprocity agreements 2. Outsource calculation of mobile employee equity compensation taxation to outside service Can be prepared for overseas as well as domestic calculations Information flows in a pre-agreed format Quick turnaround time for calculations

Need to get comprehensive and accurate data without imposing onerous requirements on business and employees. Travel Solutions The ideal process? Expense Reports Security Entry into employer s buildings? Key Issue: How to Identify and Track? Self Certification? Management s responsibility? Microchip inserted into employees? HR s responsibility? External Sources How To Track Movements? Work with travel services that can provide reports that highlight: Employees who have travel arrangements greater than 30 days Employees who have one way tickets Employees who travel frequently to the same destination Requests for long term car leases or housing in destination Work with internal functions to track irregularities: Work with payroll to identify employees receiving per diems who were not on official assignments Ask finance to review employee expenses and report those which may have tax impacts to HR leaders Add control to some automated Employee Business Expense systems to catch relocation costs Notify senior business and HR management of all short term assignees/frequent business travelers to escalate risk

How To Track Movements? Relocation vendors will notify HR leaders when: Request received from employees or managers for housing information Employees inquire about per diems Practical Guidelines

Practical Guidelines/Summary Identify how your company can track these movements Identify biggest "risk" states Identify sourcing rules by state for residents and nonresidents Review and understand withholding and reporting obligations Review and understand where foreign treaties may come into play, where state tax credits/reverse credits or reciprocity may help to minimize double taxation Determine how your company will develop a process to balance the technical requirements with administrative abilities Determine how your company will deal with employee s being double taxed (e.g., tax equalization (gross-ups), will company cover tax preparation fees) Implement a process with appropriate internal stakeholders Questions?.

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