Connecticut Employment Tax Issues

CBIA’s Connecticut Business Tax Conference

May 20, 2011

John BielloTax Division Chief, Audit Unit

Connecticut Department of Revenue Services

860-297-5962

Ray CasellaTax Attorney

Shipman & Goodwin LLP

860-251-5808

Typical Issues Arising In Employment Tax Audits

1. Under withholding

2. Unremitted tax

3. Unreported wages

4. Deposit and reporting compliance

5. Worker Misclassification

#1 Under-Withholding

What the auditors will do

They will ensure that you are withholding pursuant to your employees’ Forms CT-W4

They will review your Forms CT-W4

They will review your payroll records

If you didn’t withhold the amount required by the Form CT-W4, you will have to pay the difference to the DRS + Interest and Penalties

#1 Under-Withholding What you should do

Make sure you have a valid Form CT-W4 from each employee

A Form CT-W4 that claims an exemption from withholding is only valid for one year

Make sure you withheld (and are withholding) in accordance with each employee’s Form CT-W4

Obtain a Form CT-W4NA from nonresident employees who work within and outside of CT

#2 Unremitted Tax

What the auditors will do

They will ensure that the money you are withholding from your employees’ paychecks is being paid to the DRS.

Failing to pay withheld tax to the DRS can result in:100% Responsible Person PenaltyCriminal Prosecution (fines and jail)

#2 Unremitted Tax

What you should do

Keep good recordsPayroll recordsAccounting recordsBank records

Review the work of your payroll personnel to ensure that they are properly remitting withheld taxes

#3 Unreported Wages

What the auditors will do

They will look for evidence of the following:

Paying workers in cash

Paying personal expenses of workers

Providing, but not reporting, taxable fringe benefits

#3 Unreported Wages

What you should or should not do

Do not pay employees in cash

Do not pay personal expenses of employees

Review all benefits provided to employees and make sure that taxable benefits are included in the employees’ wages

Develop and require substantiation procedures for reimbursing for employee business expenses

#4 Deposits and Reporting

What the auditors will do

Review tax deposits for timeliness

Review payroll tax returns and statements for accuracy and timeliness

Review filings for compliance with the electronic filing requirements

#4 Deposits and Reporting

What you should do

Understand your deposit and reporting requirements

Understand the electronic filing requirements

Keep copies of all payroll tax deposits, payroll tax returns, and information returns provided to workers

#5 Worker Classification

What the auditors will do

They will review your accounting records to locate payments to independent contractors

They will analyze the level of control you have over these workers to determine if these workers are really misclassified employees

THIS IS A BIG ISSUE WITH THE DRS & THE IRS

#5 Worker Classification

What you should do

Review your relationships with independent contractors

Apply to those relationships the old 20-factor test for determining if a worker is an employee or an independent contractor

Do this now, this is a big issue with the IRS & DRS

#5 Worker Classification

Common misclassification situations

Part-time workersTemporary workers

Seasonal help – summer help – holiday helpFamily members

Retirees rehired as contractorsConsultants who – over time – end up spending all or

most of their time providing services to you.

The Classification Process

Who Are Employees?This is the hard questionMust follow the Classification Process

Who are Independent Contractors?This is the easy questionThey are workers who are not employees.

The Classification Process

Employees include the following workers:

Corporate Officers

Statutory Employees

Common Law Employees

The Classification Process

Common Law Employees

A worker is an employee under the common law if the employee/employer relationship exists between the service provider and the service recipient.

The Classification Process

The Common Law Employee/Employer Relationship

The employee/employer relationship exists when the service recipient has the right to control and direct the service provider, not only as to the result to be accomplished by the work but also as to the details and means by which that result

is accomplished.

The Classification Process

The Common Law Employee/Employer Relationship

An employee is subject to the will and control of the employer not only as to what shall be done but how it shall be done.

The Classification Process

The Common Law Employee/Employer Relationship

It is not necessary that the employer actually direct or control the manner in which the services are performed; it is sufficient if he has the right to control.

The Classification Process

The Common Law Employee/Employer Relationship

The 20 Factor Test

20 factors have been developed to help determine if an employee-employer relationship exists.

The importance of each factor depends on the occupation and the facts in each case.

The Classification Process

The Evolution of the 20 Factor Test

The common law “20 Factor Test” has evolved into three categories of evidence to use to determine if the right to control the means by which a worker accomplished the work.

The Classification Process

Three Categories of Evidence:

Behavioral Control Evidence

Financial Control Evidence

Relationship of the Parties Evidence

The Classification Process

Behavioral Control Evidence

Behavioral control evidence includes facts that show whether the business has a right to direct and control how the worker does the task for which the worker is hired

The Classification Process

Financial Control Evidence

Financial control evidence includes facts that show whether the business has a right to control the business aspects of the worker's job

The Classification Process

Relationship of the Parties Evidence

Facts that show the parties‘ relationship include:

Written contracts describing the intended relationship

Whether the worker receives employee-type benefits

The permanency of the relationship

The extent to which services performed by the worker are a key aspect of the regular business of the company.

What to Do?

Consult a Tax Advisor Perform a Self-Audit Contact the IRS for Help – Form SS-8 Section 530 Relief – from IRS

A worker’s classification will be respected by the IRS if :1. Consistent Treatment2. Consistent Reporting 3. Reasonable Basis

The DRS does not (formally) have a similar program

Multi-State Employees

Connecticut residents working both in Connecticut and in another state.

Connecticut nonresidents working both in Connecticut and in another state.

Multi-State Employees

CT resident working in CT and another state

General Rule: All wages of a CT resident are subject to CT withholding, even though some services are provided in another state.

Modification: If the employer is required to withhold income tax for services in another state, the amount of CT withholding can be reduced.

Multi-State Employees

CT resident working in CT and another state

Step 1: Determine the other state’s actual withholding

Step 2: Determine CT withholding as if all services performed in CT (“Total CT Withholding”)

Step 3: Prorate the Total CT Withholding between a CT portion and a non-CT portion

Step 4: Compare other state’s actual withholding to non-CT prorated portion.

Step 5: Withhold CT prorated portion plus the excess, if any, of the non-CT prorated portion over the other state’s actual withholding

Multi-State EmployeesCT resident working in CT and another state

Example 1:

Connecticut Resident earns $1,000

Works 40% in CT & 60% in MA

Required MA withholding is $25

Multi-State Employees

CT resident working in CT and another stateStep 1: Determine MA withholding = $25

Step 2: Determine Total CT Withholding as if all wages earned in CT

$1,000 X 5% = $50

Step 3: Prorate Total CT Withholding

MA Prorated Portion $50 x 60% = $30

CT Prorated Portion $50 x 40% = $20

Multi-State Employees

CT resident working in CT and another state

Step 4: Compare other state’s actual withholding to non-CT prorated portion:

MA prorated portion $30

MA actual withholding $25

Excess MA prorated portion

over MA actual withholding $5

Multi-State Employees

CT resident working in CT and another state

Step 5: Withhold CT prorated portion plus the excess, if any, of the non-CT prorated portion over the other state’s actual

withholding:

CT prorated portion $20

Plus: Excess MA prorated portion

over MA actual withholding $5

Equals: Required CT withholding $25

Multi-State Employees

CT resident working in CT and another state

Example 2:

Connecticut Resident earns $1,000

Works 40% in CT & 60% in MA

Required MA withholding is $35

Multi-State Employees

CT resident working in CT and another state

Step 1: Determine MA withholding = $35

Step 2: Determine Total CT Withholding as if all wages earned in CT

$1,000 X 5% = $50

Step 3: Prorate Total CT Withholding

MA Prorated Portion $50 x 60% = $30

CT Prorated Portion $50 x 40% = $20

Multi-State Employees

CT resident working in CT and another stateStep 4: Compare other state’s actual withholding to non-CT

prorated portion:

MA prorated portion $30

MA actual withholding $35

Excess MA prorated portion

over MA actual withholding $0

Multi-State Employees

CT resident working in CT and another state

Step 5: Withhold CT prorated portion plus the excess, if any, of the non-CT prorated portion over the other state’s actual

withholding:

CT prorated portion $20

Plus: Excess MA prorated portion

over MA actual withholding $0

Equals: Required CT withholding $20

Multi-State Employees

CT resident working in CT and another state

Comparison Example 1 Example 2

Actual MA Withholding 25 35

MA Prorated Portion 30 30

CT Prorated Portion 20 20

Required CT Withholding:

CT Prorated Portion 20 20

Excess MA prorated over actual MA 5 0

Total required CT withholding 25 20

Multi-State Employees

Nonresident working in CT and in another stateGeneral Rules: Wages paid to a nonresident for services rendered in CT are subject to CT income tax withholding.

Employers must withhold CT tax on all wages paid to a nonresident, unless the employer can properly determine (allocate) the wages attributable to services rendered in Connecticut.

14-Day Exception:Employers are not required to withhold CT income tax from wages paid to nonresident employees for services performed in CT if the employee is assigned to a primary work location outside of CT and works in14 or fewer days during the year.

Multi-State Employees

Nonresident working in CT and in another state

Two methods to allocate wages to CT:

1. Form CT-W4NA Method

2. Adequate Current Records Method

Multi-State Employees

Nonresident working in CT and in another state

Form CT-W4NA Method

Form CT-W4NA - Employee’s Withholding Certificate Nonresident Apportionment

Employer can obtain Form CT-W4NA from the employee and rely on the estimated percentage of services performed in Connecticut provided on the Form CT-W4NA by the employee.

Multi-State Employees

Nonresident working in CT and in another state

Adequate Current Records Method

If an employer maintains current records to determine the amount of a nonresident’s wages paid for services performed in CT, the employer can withhold CT tax based on those records, whether or not the employee filed a CT-W4NA.

Multi-State Employees

Nonresident working in CT and in another stateDetermining the amount of CT tax to withhold:

Form CT-W4NA MethodDetermine the amount that would be withheld if all wages were attributable to CT and multiple that amount by the percentage listed on the CT-W4NA.

Adequate Current Records MethodDetermine the amount that would be withheld if all wages were attributable to CT and multiple that amount a fraction the numerator of which is the wages paid for services performed in CT and the denominator is the total wages paid for the year wherever performed by the percentage listed on the CT-W4NA.

What is New at the DRS

DRS Delinquency InitiativeTaxes and taxpayers coveredTax periods involvedDescription of the program What it means to taxpayers