Utah Pass-Through Entity Withholding Tax Rules

Utah defines a pass-through entity (PTE) as an entity whose income, gains, losses, deductions, and credits flow through (via a Schedule K-1) to its owners for purposes of paying income tax.  A PTE is subject to Utah withholding requirements if one or more of its owners is an entity or is a Utah nonresident individual.  Therefore, this withholding is not strictly a nonresident withholding tax.  Withholding is also required if the PTE has an entity owner, even if that entity-owner is located in Utah and is owned by Utah residents.

The PTE withholding tax began in 2009 and applied to general partnerships, limited partnerships, limited liability partnerships, limited liability companies (if classified as a partnership for federal income tax purposes), and S corporations.  Composite nonresident tax return filings were eliminated at that time.  Beginning in 2013, trusts and estates will also be classified as PTEs if they distribute (or are required to distribute) income to beneficiaries.  Entities that are disregarded for federal purposes are classified in the same manner as for federal income tax.

A PTE is required to withhold 5% on allocations to entity owners or nonresident individual owners of Utah business income and any non-business income derived from or connected with Utah sources.  Portfolio income is categorized separately from non-business income if the PTE owner is not required to include the portfolio income as Utah income.  Portfolio income is attributable to the state of the PTE owner's residency.  Portfolio income generally includes gross income from interest, dividends, royalties, capital gains, and certain other items if not earned in the ordinary course of the PTE's trade or business.

The withholding tax must be paid on or before the original due date (without extensions) for the PTE's tax return.  The PTE must provide a Utah Schedule K-1 to its owners showing the allocated withholding amount.

A PTE may elect a waiver of its Utah withholding requirement.  The waiver may be for one or more of its owners subject to withholding.  However, if the owner fails to file a Utah income tax return and pay its Utah tax, the PTE will be assessed the tax, including any interest and penalty.

A special rule applies if the PTE intending to elect a waiver is itself also owned by a PTE (a "downstream" PTE), and the downstream PTE is owned entirely by Utah resident individuals.  In this case, the waiver can only be elected if all of the downstream PTEs and Utah resident individuals file their tax returns and pay their Utah tax on or before the PTE's Utah tax return filing due date, including extensions.  This will require Utah resident individuals to file their extended tax returns one month earlier than otherwise allowed.  For example, assume XYZ, LLC operates a Utah business and is partially owned by ABC, Ltd. (a family limited partnership) that in turn is owned solely by Utah resident individuals.  Assume XYZ, LLC's and ABC, Ltd.'s tax return due dates are April 15th and that they have obtained five-month extensions (maximum extension period for partnerships) to September 15th.  Assume further that the Utah resident individuals have obtained six-month extensions (maximum extension period for individuals) moving the due date of their tax returns to October 15th.  In order for XYZ, LLC to be eligible to elect a waiver from the Utah withholding requirement applicable to the ownership interest held by ABC, Ltd., both ABC, Ltd. and all of its Utah resident individuals must file their Utah tax returns, and pay their Utah income tax, by September 15th, the filing due date for XYZ, LLC, even though the Utah resident individual income tax returns aren't due until October 15th.

Temporary Expansion of the Voluntary Worker Classification Settlement Program

On December 17, 2012, the IRS issued Announcement 2012-46 temporarily modifying the Voluntary Worker Classification Settlement Program originally established on September 21, 2011 (see prior post).  This is a program that reduces the penalties on employers who come forward to correct workers misclassified as independent contractors who instead should have been classified as employees.  There is not a bright-line test in properly classifying workers, and errors can be made.  In addition, workers classified as employees are much more costly to a business than if the workers were instead classified as nonemployees.  Examples of additional costs are payroll taxes, health insurance (if offered to employees), and retirement plan (if offered to employees) contributions.  Therefore, some businesses may have tended toward classifying workers as independent contractors.  If the IRS discovers that workers were misclassified, the IRS can impose years of back taxes, interest, and penalties on the employer.  In addition, the employer could be responsible for past overtime pay, retirement plan contributions, and other employee fringe benefits.  With potential penalties building up over the years, employers felt stuck with the problem without a low-cost way of correcting the misclassification. 

Under the 2011 settlement program, the employer was not eligible to participate if it had not issue all required Forms 1099 for their workers during the three prior years.  The modified program allows employers that did not file required Forms 1099 to participate in the settlement program, but only if application is made on or before June 30, 2013.  The cost of entering into the modified program is higher than the regular program. 

The modified settlement program enables eligible employers to obtain substantial relief from past taxes, penalties, and interest if they prospectively treat workers as employees. To be eligible, a business must:

 

1.    Have consistently treated the workers in the past as nonemployees,

2.    Not be currently under an employment tax audit by the IRS, and

3.    Not be currently under audit by the Department of Labor or by a state agency concerning the classification of these workers.

Eligible employers must file Form 8952 with the IRS by June 30, 2013.  Employers accepted into the program will be required to electronically file all required Forms 1099 for the prior three years, in accordance with IRS instructions that will be provided once the IRS has reviewed the application and verified that the employer is eligible for the modified settlement program. 

Employers accepted into the temporary, modified program will pay a penalty of from 1.26% to 1.97% of wages (up from about 1% under the regular program) paid to the reclassified workers for the past year.  The IRS will not audit the employer for payroll taxes related to these workers for prior years. 

In addition to the reduced payroll tax penalty, a reduced penalty on the late filing of Forms 1099 will apply.  The amount of the penalty is based upon the total number of Forms 1099 that should have been filed during the three prior years.  The amount penalty is: 

1.     From 1 to 25 non-filed forms, the lesser of $500 or $50 per form.

2.     From 26 to 49 non-filed forms, the lesser of $3,675 or $75 per form.

3.     For 50 or more non-filed forms, the lesser of $10,000 or $100 per form.

This is a voluntary Federal program.  Participation in the program could be shared with states that may or may not have a voluntary compliance program of their own.  Note also that correcting worker classification may have an impact under the 2014 health insurance mandate for employers having 50 or more employees beginning in 2013.

New W-2 Reporting Duty for "Large" Employers

As the year 2012 draws to a close, employers will be busy preparing Form W-2 for their employees.  Form W-2 must be provided to employees no later than January 31, 2013.  Under the new health care reform law, employers that filed 250 or more W-2's for 2011 (prepared in January 2012) are classifed as "large" employers for this purpose and must report the aggregatge cost of employer-provided health insurance on W-2's for 2012 (prepared in January 2013).  Employers that filed less than 250 W-2's for 2011 do not have to report the cost of health insurance on the W-2, even if they have 250 or more W-2s for 2012.

The cost is to be reported in box 12 of Form W-2 using the code "DD."  The cost is for information reporting only; it is not taxable compensation to the employees and therefore should not be included with other compensation reported in boxes 1, 3, or 5 of Form W-2.

The "aggregate cost" of employer-provided health insurance follows these general rules.  Be sure to check IRS Notice 2012-9 for your specific circumstances.

1. Include premiums paid by the employer.
2. Include premiums paid by the employee (whether pre-tax or after-tax).
3. Include COBRA premiums of former employees and beneficiaries.
4. Exclude pre-tax employee contributions to health flexible spending accounts.
5. Exclude contributions to a health savings account.
6. Exclude coverage for long-term care.
7. Exclude the cost of separate policies covering dental or vision.

The IRS has reserved the right to lower the 250 W-2 threshold in the future, so smaller employers may yet have to deal with this paperwork requirement.