LawFlash

Grace Period to Comply with PA Nonemployee Income Tax Withholding Nears End

June 06, 2018

Businesses and nonprofits operating in Pennsylvania that hire independent contractors or corporate directors who live outside of Pennsylvania, or that pay rent on Pennsylvania property to landlords living outside of Pennsylvania, must carefully consider new Pennsylvania withholding rules that will be enforced beginning on July 1, 2018. 

In October 2017, Pennsylvania enacted a statute[1] substantially expanding income tax withholding beyond employee wages to require withholding of Pennsylvania income tax—at the applicable income tax rate (currently 3.07%)—from compensation equal to or greater than $5,000 annually paid to any independent contractor or corporate director who is not a Pennsylvania resident but who performs services in Pennsylvania. The new withholding rules also apply to “disregarded entities”[2] with a nonresident owner who performs services in Pennsylvania (which apparently will require payors to obtain information from such payees as to whether their owners are nonresidents). Finally, the new rules apply to any rent payments equal to or greater than $5,000 annually paid to nonresident landlords for the lease of Pennsylvania property.

These requirements became effective on January 1, 2018. However, the Pennsylvania Department of Revenue (PA DOR) decided that any income subject to these new withholding provisions would not be subject to an underwithholding assessment if a payor fails to withhold for a period ending prior to July 1, 2018[3]—effectively delaying the enforcement date until July 1, 2018.

Potential for Invalidation, Further Delay

Currently, there is a constitutional challenge to Pennsylvania’s Act 43 of 2017 in Commonwealth Court that has the potential to invalidate the new withholding requirements, change the effective date of the new withholding rules, or further delay their enforcement date.[4] In addition, the Pennsylvania Institute of Certified Accountants has requested that the PA DOR delay the withholding obligations’ effective date until January 1, 2019. And on May 7, Rep. Keith J. Greiner (R) introduced a bill in the Pennsylvania General Assembly (HB 2413), which aims to streamline and clarify many issues with the new requirements, including how to determine nonemployer withholding on payments to payees that relate to business engaged within and outside of the commonwealth.

If the enforcement date is not delayed, this expansion of Pennsylvania income tax withholding requirements to nonemployee compensation and leases of Pennsylvania real estate from nonresident landlords will create further administrative burdens on businesses and nonprofits by subjecting them to substantial additional withholding and reporting requirements.

How to Comply

To comply, businesses and nonprofits operating in Pennsylvania must

  • determine which of their payees fall under the new withholding rules,
  • apply for a Form 1099-MISC withholding account with the PA DOR (complete PA-100 electronically here), and
  • file quarterly withholding tax returns (and annual Form REV-1667R) remitting the applicable withholding payments to the PA DOR.

Going forward, the PA DOR will require taxpayers to file Form 1099-MISC annually for all Pennsylvania-source payments as long as the Form 1099-MISC is required at the federal level. Note that, unlike employee compensation, state reciprocity agreements do not apply to payments made to nonresidents under this withholding requirement. Therefore, this specific withholding is still required for payees who are residents of Indiana, Maryland, New Jersey, Ohio, Virginia, and West Virginia.[5]

Takeaways

Businesses and nonprofits operating in Pennsylvania that make payments to Pennsylvania nonresident independent contractors or corporate directors, or that pay rent for Pennsylvania property that is equal to or greater than the $5,000 annual payment threshold to any nonresident landlords, should comply with the withholding requirements beginning on July 1, 2018 or risk liability (imposable on any payor that has failed to withhold) for the Pennsylvania taxes, penalties, and interest due on these payments.

Nonresident independent contractors and corporate directors who have failed to properly pay their Pennsylvania income taxes in one or more prior years should consider participating in Pennsylvania’s Voluntary Disclosure Program to mitigate any past due tax liability, as the PA DOR will likely look to reconcile the 1099 company filings against the tax filings of nonresident independent contractor and corporate directors to guard against income tax that was not paid.

Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Boston
Donald-Bruce Abrams

Chicago
Adam Beckerink
Matthew Mock

New York
Mary B. Hevener
Cosimo A. Zavaglia

Philadelphia
Justin D. Cupples
Ester Lee

Pittsburgh
Randall C. McGeorge

Washington, DC
Patrick Rehfield



 

[1] See Section 316.2 of the Tax Reform Act of 1971, as amended by Act 43 of 2017.

[2] Pursuant to Section 316.2(a)(1) of the Tax Reform Act of 1971, as amended by Act 43 of 2017, a disregarded entity is “[a]n entity that is disregarded under section 307.21 that has a nonresident member.” Note, this is a direct reference to a specific provision under 72 P.S. § 7307.21, which states “an unincorporated entity that has a single owner shall be disregarded as an entity separate from its owner.”

[3] However, if tax is withheld before July 1, 2018, then it must be filed and remitted as required by Act 43. Also, a nonemployee’s income for all of 2018 would be required to be reported on 1099-MISC for 2018, even if it was not subjected to withholding of Pennsylvania income taxes.

[4] In a petition filed with the state’s Commonwealth Court, a coalition of fireworks retailers argued that Act 43 of 2017, passed last year as part of the state’s budget, should be struck down as unconstitutional. See Phantom Fireworks et al. v. Wolf et al., 21 M.D. 2018 (filed January 19, 2018).

[5] Note, HB 2413 would respect the state’s reciprocal agreements and not require payors to withhold on payees who are residents of Indiana, Maryland, New Jersey, Ohio, Virginia, and West Virginia.