Withholding for Outside Directors—Pennsylvania-Style
June 11, 2018
Two weeks ago, I blogged that you shouldn’t withhold taxes for outside directors, but if you’ve worked in equity compensation for any time at all, you’ve figured out that there’s an exception to every rule. Pennsylvania—that state that brought you withholding for ISOs and ESPPs—is aiming to be an exception to this rule.
Pennsylvania’s New Withholding Law for Nonresident Nonemployees
Last year, the general assembly of Pennsylvania passed Act 43, which requires companies to withhold PA personal income tax on payments of PA-source income to nonresidents performing services as outside directors, independent contractors, and other nonemployees, if the payments exceed $5,000 per year.
The law was scheduled to go into effect on January 1, 2018 but was delayed until July 1, 2018 (and there are challenges to the law that could delay the effective date even further, so check with your tax advisors before starting withholding).
I know, right? This seems crazy and confusing. There are two key things to know about the new law:
- Withholding on compensation paid to nonemployees is only required on PA-source income. In the context of compensation, this is payment services performed in Pennsylvania.
- Withholding for nonemployees is only required for those who aren’t residents of PA. You don’t have to withhold PA PIT for nonemployees who reside in PA.
The upshot here is that this new requirement is most likely to be a concern for Pennsylvania-based companies, and companies that hold board meetings in Pennsylvania, that have directors who live outside of Pennsylvania.
If your company is not located in Pennsylvania and you don’t hold board meetings in the state, you likely don’t have to worry about this for your outside directors. Likewise, if your company is located in PA, but all of the outside directors on your board reside in PA, you also shouldn’t have to worry about this. But if you are a PA-based company and you have one or more outside directors who reside outside of PA, you should ask your tax advisors to look into this new law for you.
For other nonresident nonemployees (e.g., contractors), the withholding requirement is based on whether they perform services in Pennsylvania. For example, if you have offices in Pennsylvania and bring in out-of-state contractors to perform services in those offices, you might have to withhold tax on the amounts paid to those contractors.
Withholding and Reporting
When withholding of PA PIT is required for outside directors, the withholding rate is 3.07%. I have no idea why the rate such an odd number but given everything else Pennsylvania does, it hardly seems surprising.
The taxes withheld are reported in box 16 of Form 1099-MISC; the company will then have to file the Form 1099-MISC with the state, in addition to filing it with the IRS and providing a copy to the nonemployee.
Do Any Other States Require This?
Not that I know of, although I learned that CA sometimes requires withholding on payments made to contractors who live out of state, but specifically exempts payments to outside directors.
Here are some links to more information about the new law:
- PA Department of Revenue Fact Sheet (the fact sheet says the law went into effect on January 1, but the effective date has been extended to July 1 and may be extended further)
- Act 43 of 2017 (see section 316.2)
- Blog posts at Morgan Lewis and Schneider Downs
Thanks to Tami Bohm of Radian Group for bringing this to my attention. Thanks also to Marlene Zobayan of Rutlen Associates for helping me do some research on the law.