The Pennsylvania Department of Revenue last week issued the anticipated guidance for a new non-employee and rent withholding requirement that was passed as part of the ’17-’18 state budget this fall. Informational Notice PIT 2017-01 can be found here. Contractors and other business types as well as non-profits operating in Pennsylvania must carefully consider these new withholding rules if they hire independent contractors that live outside of Pennsylvania or pay rent to nonresident landlords.
Effective January 1, 2018, businesses and non-profits that expect to make non-employee Pennsylvania-source payments of at least $5,000 to non-resident individuals and single-member LLC’s that have a non-resident individual member will be required to withhold Pennsylvania personal income tax on these payments. Withholding is optional if the payments do not exceed $5,000 per payee in a year.
So what type of payments fall under this requirement?
Any payments made to an individual living outside of Pennsylvania who is not an employee but performs services in the course of your trade or business is subject to this withholding requirement. Additionally, lease payments made by a business or non-profit to a landlord that is a nonresident individual, trust, or estate will also be subject to this withholding requirement, even if payments are made to a Pennsylvania intermediary.
If the business or non-profit does not initially anticipate payments to a particular payee will exceed $5,000 for the year but ultimately does reach that amount, how does the Department of Revenue expect withholding to be handled in this situation?
That’s the million-dollar question! Withholding on payments to a payee of less than $5,000 a year are not subject to withholding. However, in situations when the payments exceed the threshold but were originally not anticipated by the payor, it is unclear how a business should handle the reporting in this situation. The Department simply states that it “encourages” you to withhold if you are unsure of the total amount of payments that will be made to a payee. This wording could suggest that a business that fails to initially withhold in this situation may be able to escape penalties if can show it operated in good faith and with reasonable due diligence, and the business begins withholding as soon as payments were expected to exceed $5,000. However, to avoid risk, voluntarily withholding in scenarios where payments may come close to $5,000 a year may be the best course of action for a business.
What are the next steps for payors that will need to withhold on payments to either independent contractors or lessors under this requirement?
- Businesses and non-profits must review their accounts payable in order to determine which of their vendors/payees may fall under these new withholding rules. One apparent challenge will be determining which LLC’s are multi-member vs. single-member, and if the LLC is in indeed a single-member, determining in which state the member resides.
- Payors meeting the withholding requirements are required to apply for a 1099-MISC withholding account via the Form PA 100, which can be done electronically at pa100.state.pa.us.
- The business will be required to file quarterly withholding returns as well as annual reconciliation reports.
- Withholding payments are to be remitted to the Department quarterly, monthly, semi-monthly, or semi-weekly depending on the total amounts being withheld by the business. Failure either to withhold or properly remit will subject the payor to the same penalties as Pennsylvania employers face for withholding requirements for their employees.
Lastly, some things to keep in mind. 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 that are residents of Maryland, New Jersey, West Virginia, Ohio, Virginia, and Indiana. Prior to 2018, the Pennsylvania Department of Revenue required the filing of 1099-MISC in certain situations. Now, Pennsylvania will require 1099-MISC’s to be filed annually with the Department for all Pennsylvania-source payments, whether they meet the $5,000 threshold or not, and whether it is for a resident or non-resident payee, as long as a 1099-MISC was required at the Federal level. This includes payees that are partnerships, which are not included under the withholding requirements detailed above.
As one might expect, these new withholding/reporting requirements were met with objection from the business community. While the concept of withholding on these payments is reasonable from the payee’s perspective, this places an additional administrative burden on the payor to administer another set of withholding and reporting requirements, when in many cases, the withholding required under this requirement by any one payor may be relatively small. Nevertheless, it is now the law, and it is effective beginning January 1, 2018.
Michael Eby, CPA is a Senior Manager and leader of the firm’s state and local tax consulting practice. If you have any questions regarding this article or would like to speak to someone about our services, please email Michael at firstname.lastname@example.org.