Apportionment Issues: Pyroll Factor--Leased Employees

Schadewald, Michael
January 2007
Journal of State Taxation;Jan/Feb2007, Vol. 25 Issue 2, p9
Academic Journal
Under Uniform Division of Income for Tax Purposes Act (UDITPA) �13, the payroll factor is a fraction, the numerator of which is the total amount of compensation paid in the state by the taxpayer, and the denominator of which is the total compensation paid everywhere. For this purpose, the term compensation means �wages, salaries, commissions and any other form of remuneration paid to employees for personal services.� Under the Multistate Tax Commission (MTC) regulations, only amounts �paid directly to employees� are included in the payroll factor, and any payments made to an independent contractor or any other person not properly classifiable as an employee are excluded.2 For this purpose, the term �employee� means any officer of a corporation, or any individual who, under the usual common-law rules applicable in determining the employer-employee relationship, has the status of an employee. Generally, a person is considered an employee for payroll factor purposes if he or she is treated as an employee for FICA tax purposes. Employee leasing generally refers to a situation where a third-party company �employs� the taxpayer's staff by taking over various legal responsibilities, including distributing paychecks, withholding and depositing personal income taxes, making FICA contributions, providing worker's compensation insurance, and administering other employee benefits. In return for this service, the taxpayer pays the third-party company a cost-plus fee. In many cases, the taxpayer maintains significant control over the activities of a leased employee. As a consequence, a leased employee may be considered an employee of the service recipient under the common-law rules. UDITPA and MTC regulations are silent regarding how the compensation costs associated with leased employees are properly treated for purposes of computing the payroll factor. One approach is to include a leased employee's compensation in the payroll factor of the employee-leasing company (the lessor), because that is the entity directly paying the individual in question. An alternative approach is to include a leased employee's compensation in the payroll factor of the common-law employer, which could be either the employee-leasing company or the entity for which the employees are providing services (the lessee). Some states provide specific guidance regarding the treatment of leased employees, but many states do not. For example, for purposes of computing the Massachusetts payroll factor, compensation paid for personal services rendered by leased employees is included in the payroll factor of the recipient of the services of the leased employee, and is excluded from the payroll factor of the employee-leasing company. For purposes of computing the New Mexico payroll factor, compensation paid for personal services rendered by leased employees is included in the payroll factor of the recipient of the services of the leased employee if the recipient is considered to be the employer or joint employer of the leased employee for payroll tax purposes.


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