On October 30, 2017, Governor Tom Wolf of Pennsylvania signed into law Act 43 of 2017. This new law provides that beginning July 1, 2018, Pennsylvania businesses that pay at least $5,000 in Pennsylvania-source nonemployee compensation or business income to a nonresident individual (or disregarded entity that has a nonresident member) are required to withhold from such payments the current applicable income tax rate (currently 3.07 percent).
Typically, a payment is considered nonemployee compensation if it is (1) made to someone who is not your employee; and (2) for services in the course of your trade or business. “Nonemployee compensation” includes payments to independent contractors and nonresident directors.
Withholding is optional for payors paying less than $5,000 annually. However, for payors that are unsure of the total amounts of payments that will be made during the course of the year, the Pennsylvania Department of Revenue (DOR) encourages withholding and remitting income tax from all payments made.
Governmental payors are exempt from the requirement of withholding on nonemployee compensation and business income.
Although this new law was initially effective on January 1, 2018, due to the significant burden of compliance, the DOR delayed implementation until July 1, 2018. The DOR announced that payors that failed to withhold for a period prior to July 1, 2018, will not be subject to penalties. Pennsylvania law imposes a 5 percent penalty for failure to timely withhold. Although the law is not formally effective until July 1, 2018, it is suggested that payors begin withholding for 2018 as soon as possible to avoid any backup withholding obligations. The DOR also stated that it expects payors to timely file Form(s) 1099-MISC, with boxes 16 and 17 completed, in January 2019.
As a result of this new law, payors should communicate with their payroll departments as soon as possible in advance of the July 1 start date and be prepared to withhold Pennsylvania income tax on the relevant compensation payments. The deposit schedules applicable to employer-withheld state income tax apply to payments covered by Act 43. Also, if a payor does not already have a Pennsylvania withholding account, or the payor has a withholding account and wishes to report its Form 1099-MISC payments separately, then the payor should complete a PA-100 Pennsylvania Enterprise Registration Form.
As the nonemployee segment of the United States economy continues to expand, altering traditional employment relationships and associated tax withholdings, states may contemplate new means of ensuring revenue streams. Pennsylvania’s Act 43 may be a harbinger of other state legislative action. Other states are likely watching closely to see how Act 43 impacts both payors and nonemployees.
Some concerns exist. For example, payors will need to enhance their capabilities to track where nonemployee service providers perform services and implement withholding accordingly. This may present a challenge for entities in the gig economy that use technology platforms to connect nonemployee service providers with payors’ customers (e.g., ridesharing or lodging rental entities). In such cases, each “gig” may be provided from a different location.
From the nonemployee perspective, the concerns may be different and may be financially based, rather than administrative in nature. By withholding on the gross compensation received before business expenses are accounted for, the taxable wages of a nonemployee may be overstated and the withholding performed may not reflect the nonemployee’s actual tax burden. This may be particularly harmful in industries with high-expense ratios and narrow profit margins. In such situations, nonemployees may have to wait until receiving their tax return refunds to recognize the profit from their business activities.
As such, many interested parties will be watching to see how Act 43’s withholding requirements may transform the nonemployee segment of the economy.