By Mark Feldstein
No one likes to receive a bill for taxes, penalties and interest from a state where they’ve never lived — especially without a clear understanding of why they are receiving it. But if your company has stakeholders who aren’t domiciled in the states your business operates in, your company may be required to pay nonresident taxes on their behalf.
If you’re not aware of nonresident withholding taxes and how they work, you could end up with confused, angry shareholders come tax time. Here’s what you need to know to keep everyone on the same page.
What are nonresident withholding taxes?
Nonresident withholding taxes could apply if your company operates a flow-through company, such as a partnership, ‘S’ corporation or an LLC operating as a partnership. In flow-through companies, taxation of income is typically passed through to the individual rather than the business. The stakeholders are individuals who’ve invested in the company and stand to share an allocable portion of the profits, if any.
While individual stakeholders may live in one state, their company may operate in other states. The stakeholder is responsible for filing an individual tax return for each state in which the company operates and paying the respective taxes for that state’s allocable income. However, some stakeholders seem to ignore state filing requirements for states other than the one they live in. In order to make sure they receive taxes, a growing number of states require companies with nonresident stakeholders to submit estimated quarterly payments or an end-of-year payment. It becomes the responsibility of the company.
How to simplify
There are three steps companies can take to minimize the complexity and year-end hassles of nonresident state withholding taxes.
- Alert your stakeholders. Don’t keep stakeholders in the dark about potential taxes, or the challenges that may come with them. Have your controller explain the situation upfront and provide options for dealing with the complexity in different states where you do business. The controller should already be providing stakeholders with estimated income projections and state allocation information on a periodic basis, and this is a good time to alert the stakeholders about their tax requirements, whether it is the responsibility of the company or the stakeholders themselves.
- Educate your controller. It’s not always stakeholders who are left scratching their heads when it comes to varying state tax laws. Your controller may be equally stumped. Have your controller consult an accountant, who can help unbundle the issue and explain how to process filings in each tax location. Controllers can also have trouble determining to how to account for these taxes on the company’s books and records, confusing tax-deductible expenses with what could very well be stakeholder distributions.
- Consider filing composite returns. To simplify the lives of your stakeholders, it is sometimes beneficial to file the tax returns on their behalf, removing that responsibility from individual participants. Because your company is already tasked with managing multiple tax issues, adding one more might be less confusing for you than for your affected stakeholders.
The key is to make sure everyone is on the same page in terms of how your state taxes will be handled. Penalties and interest can stack up if your company or a stakeholder isn’t making required quarterly payments. Doubling up, whereby the stakeholder and company are both paying quarterly estimated taxes, can be especially aggravating and tie up available company and individual cash flow, so make sure both your company and its stakeholders are in sync.
By working with your accountant to review taxation requirements in all relevant states, you can plan your strategy for withholding taxes and tax filings and inform your stakeholders in a timely manner. A proactive approach will position your team to cut through the confusion and keep your stakeholders out of trouble.
Mark Feldstein, CPA, PFS is a partner in the New York City office of Wiss & Company LLP. You can reach Mark at firstname.lastname@example.org or 973.994.9400.