Nuances of State Reporting Series, No. 2: Top 10 List of State Reporting Challenges

In recent years, states have faced budget deficits and are looking for ways to raise revenue without increasing taxes. One way to do this is to improve the enforcement of tax laws that are already on the books. Because of the improved enforcement, many companies are starting to receive penalties for requirements they didn’t know existed. Implementing strategies and policies to avoid these penalties is becoming more difficult every day. This article seeks to explain why being compliant with state reporting is so challenging 1.       41 States There are 41 states with an income tax and some form of withholding or reporting requirement. Each of these states has different regulations on what, when and how organizations must report to them. Many states mandate electronic reporting, yet there are states that still require paper returns. It can be difficult to keep track of the various regulatory obligations, especially considering many states are not extremely forthcoming about the updates that are constantly being made. It is common for a state to require information to be submitted by January 31, but often a state will not release their reporting specifications until the beginning of January. There are also instances of states releasing their specifications only to re-release them with substantial changes several weeks later. 2.       Where to look? Because every state does things slightly different, it can be challenging to locate the withholding and reporting requirements. Some state tax departments are diligent about updating a withholding guide yearly and posting it on their website. However, other states do not have a clear withholding guide, forcing tax compliance teams to search statutes, regulations, state tax websites and form instructions. Regulatory requirements can be hidden in seemingly unrelated content. For example, South Carolina requires certain backup withholding according to South Carolina’s 2008 Illegal Immigration Act. 3.       Unclear Requirements It’s great when a state provides a clear and concise information reporting guide. Unfortunately, many states do not specifically state what information returns are required and instead say something to the tune of “1099s that report withholding”.  But what does 1099 mean? Does that include 1098s, 1042, 1042-S or 5498 forms? This ambiguity can make it very difficult for businesses to ensure that they are maintaining tax reporting compliance. 4.       Impossible Requirements Often times, a state tax department will assert that they follow the Federal Publication 1220 for reporting 1099s. However, it is common that state agencies will not communicate what parts of Federal Publication 1220 they do or don’t follow. Colorado is one such example. Colorado’s FYI Withholding 7 publication requires 1099s that are submitted electronically to be in the 1220 format. However, Colorado’s systems were not updated to accept files with 1099-K returns even though the 1220 includes 1099-K information. For those states that require 1042-S reporting, many will not distinguish 1042-S from other 1099s and maintain that all 1099 reporting follow 1220 guidelines. This is an impossible requirement as 1042-S forms are not reported pursuant to the 1220 format but instead follow Publication 1187. 5.       Unwritten Requirements Too often states will have tax reporting policies that are not widely available or posted anywhere. There are several states that require reporting on Tax Exempt Government Bonds, also known as Muni-Bond Reporting. Three of these states do not post the specifications for this reporting and instead send each individual client the formatting requirements. 6.       Language Many states have an electronic filing requirement for those that file many information returns. What does electronic mean? Some states exclusively define electronic filing as electronic uploads onto their website, while other states also include submissions via CD in this definition. Pennsylvania, for example, requires payers filing 250 or more 1099-R forms to file electronically. However, Pennsylvania considers magnetic media submissions to be electronic. This is not consistent across every state so it is prudent to verify the methods of filing a state accepts and the state’s definition of each delivery method. 7.       Late Notice of Requirements/Changes The majority of states require information returns be submitted by February 28, with a few states due by January 31 or March 31. Wisconsin requires most information returns by January 31. This past year, Wisconsin didn’t release their Guide to Wage Statements and Information Returns until December. The guide that was released included an important change, no longer waiving the filing requirement for employers and other payers to submit W-2s and 1099s that did not report withholding. This is a huge change that came with only a forty-five days’ notice. 8.       CFS Confusion One of the most common questions we get is if organizations file information returns through the Combined Federal State (CFS) program, do they have any remaining direct state reporting obligations? There is a lot of confusion surrounding the CFS program, including what states participate in CFS, what forms CFS supports and what state requirements remain. The federal publication explaining CFS requirements lists Michigan and Louisiana as participating states, but these states do not accept CFS submissions. For those states that do participate, many still require direct reporting for 1099s that have state withholding. Not all 1099s have CFS forms and this also can be problematic. For those states that do not require direct reporting for returns with withholding, organization should be sure that there are not any other states requiring 1099s that aren’t CFS forms. 9.      State Call Centers not Equipped to Answer Questions After researching state withholding and reporting requirements, most tax compliance teams have a question or two. At this point, they must find the right phone number to call. Most states allow people to call the state tax department, but in California they need to know what type of withholding they are dealing with to determine whether they should call the Employment Development Department or the Franchise Tax Board. If the question is concerning a 1099-MISC payment, the call should go to the Franchise Tax Board. If the question is concerning a voluntary withholding payment on a 1099-MISC payment, they should call the Employment Development Department. Usually, there is a wait to get a hold of someone. On a normal day, this can be up to thirty minutes, but in tax season it’s usually much longer. 10.   Varying Answers from State Representatives After waiting on hold for 30 minutes, hopefully the person answering the phone is knowledgeable. Unfortunately, the reality is that many states do not have the resources to train their call center staff on the more nuanced issues. Often times, a representative will read straight from the withholding guide. If the call center representative does answer the question, it may be a different response than what someone else at the same call center will give. Varying answers from representatives are quite common and trusting any answer given is a risk often taken. However, it’s important to remember that advice given on the phone does not carry the weight of the law. State reporting is complex because of the variances in each state, from the definition of “electronic” to how states assemble the information for withholding guides. The “Nuances in State Reporting” series will highlight many of these challenges associated with state reporting and will provide guidance for overcoming the hurdles and ensuring accurate state reporting. To see the previous segment of this series click here.