CBIA 2012 Connecticut Tax Conference

1. State Income and Employment-Related Tax Issues for Businesses in Connecticut Moderated by Alan E. Lieberman, Shipman & Goodwin LLP CBIA 2012 Connecticut Tax Conference June 1, 2012

2. Connecticut Personal Income Tax Sourcing Rules & Pitfalls to Avoid for Executives Presented by: Ryan V. Leichsenring, Esq. Shipman & Goodwin LLP 860-251-5101 rleichsenring@goodwin.com

3. The Sourcing Rules – Who Cares? The sourcing rules are the mechanism that states, such as Connecticut, use to ascertain what portion of income will be taxed in situations where the taxpayer has connections to two or more states. An understanding of these rules not only is key to properly reporting compensation income, but can be very useful in retirement planning. The rules may be particularly relevant in any of the following situations:

4. The Sourcing Rules – Who Cares? 1. Nonresident taxpayers who work in Connecticut; 2. Connecticut resident taxpayers who retire and move out of Connecticut; 3. Connecticut resident taxpayers who relocate out of Connecticut and continue to work; and 4. Connecticut resident taxpayers who work outside of Connecticut (and pay taxes to the state in which they work). The important phrase: “derived from or connected with sources within this state.”

5. General Rules for Sourcing Income Nonresidents Nonresidents compute their Connecticut tax by first determining their Connecticut adjusted gross income from all sources and determining the amount owed. That amount is then multiplied by a fraction that is equal to the amount of the taxpayer’s Connecticut adjusted gross income from Connecticut sources divided by the total Connecticut adjusted gross income from all sources [CT Agencies Regs. § 12-700(b)-1].

6. General Rules for Sourcing Income Residents The Connecticut adjusted gross income of residents is federal adjusted gross income with certain modifications (i.e. all of your income regardless of source) [CT Agencies Regs. § 12-701(a)(20)-1]. Connecticut adjusts for services provided out of the state by residents by providing a credit for taxes paid to another qualifying jurisdiction [CT Agencies Regs. § 12-704(a)-1]. Although not explicitly stated, the regulations use the rules for sourcing of nonresident income to perform the same analysis for the non-Connecticut income of residents subject to the credit.

7. Sourcing of Compensation 1. Regular Wages [CT Agencies Regs. § 12-711(c)-5] • Allocation vs. Apportionment • Multiple Employers • What is a “Working Day?” • Casual, Isolated and Inconsequential Presence • Form CT-W4NA and the 15-Day Rule 2. Commissions Earned by Salespersons [CT Agencies Regs. § 12-711(b)-9] 3. Compensation on the Basis of Mileage [CT Agencies Regs. § 12-711(b)-10] 4. Restricted Stock [CT Agencies Regs. § 12-711(b)-17] • IRC § 83(b) Elections

8. Sourcing of Compensation 5. Nonqualified Stock Options [CT Agencies Regs. § 12-711(c)-18] 6. Incentive Stock Options [CT Agencies Regs. § 12-711(c)-16] 7. Deferred Compensation [CT Agencies Regs. § 12-711(c)-19] 8. Covenants Not to Compete [CT Agencies Regs. § 12-711(c)-20] 9. Pensions [CT Agencies Regs. § 12-711(c)-12]

9. Special Issues with NY-Based Employees 1. “Convenience of the Employer” Sourcing Rule • 20 NYCRR 132.18 • Zelinsky v. New York Tax Appeals Tribunal, 769 NYS.2d 464 (NY Court of Appeals 2003) • Risk of Double Taxation on Work from Home 2. Unintended Statutory Residents •Matter of Barker (NY Division of Tax Appeals, ALJ Determination) (April 7, 2011) • Risk of Double Taxation on Intangible Income

10. Beware the “Special Accrual” 1. Special Accrual Regulations [CT Agencies Regs. §§ 12-717(c)(1)-1 and 12-717(c)(2)-1] • Lack of guidance 2. New York’s Analysis: the federal “All the Events” test • The right to income is fixed • The amount of income can be determined with reasonable accuracy 3. Common Areas of Dispute • Severance Payments • Pensions (Qualified and Non-Qualified Plans; See PITLA, 4 U.S.C. §114) • Deferred Compensation (Query: Conflict with regulation?) • Non-wage items (e.g., installment sales)

11. Issues with Connecticut’s Composite Income Tax Rules Presented by: Todd D. Doyle, Esq. Shipman & Goodwin LLP 860-251-5807 tdoyle@goodwin.com

12. The Composite Income Tax:What Is It? • Entity-level tax imposed upon pass-through entities (“P/Es”) having nonresident partners/members/shareholders • Statutory Scheme • Partnerships (and limited liability companies taxed as partnerships) C.G.S. § 12-719(c)(1) • S corporations C.G.S. § 12-719(c)(1) • Requirement to file composite return C.G.S. § 12-726

13. The Composite Income Tax:Relevant Statutes • C.G.S. § 12-719(b)(1) “With respect to each of its nonresident partners, each partnership doing business in this state or having income derived from or connected with sources within this state shall, for each taxable year, make payment to the commissioner as provided [in the statute].” • C.G.S. § 12-719(c)(1) “With respect to each of its nonresident shareholders, each S corporation doing business in this state or having income derived from or connected with sources within this state shall, for each taxable year, make payment to the commissioner as provided [in the statute].”

14. The Composite Income Tax:Relevant Statutes (Continued) • C.G.S. § 12-726 Partnerships or S corporations doing business in Connecticut or deriving income from Connecticut sources need to file a composite return setting forth this information.

15. The Composite Income Tax:Application/Enforcement • P/Es not required to make estimated payments. • After January 1, 2008, P/Es may NOT rely upon a statement by a member that a Connecticut income tax payment has or will be made by the member for the taxable year. IP 2006(22). • P/E liable for interest (1% monthly) and penalties (10%) for making late composite income tax payments. • Collection first sought from P/E, but DRS will pursue individual members if unable to collect from P/E.

16. The Composite Income Tax:Determination of Connecticut Source Income • Determined differently for P/Es than for corporate taxpayers. • C.G.S. §§ 12-218 et seq. generally requires corporate taxpayers to apportion their income using a three-factor or one-factor formula with sales allocated to a jurisdiction based upon location of the customer. • Connecticut currently directs P/Es to apportion sales based upon the percentage of sales or services performed through a Connecticut office. • Apparent audit focus in recent years, notwithstanding prior acquiescence with P/Es use of the corporate method.

17. Conn. Agencies Regs. § 12-711(c)-4(a) • Income of a nonresident P/E attributable to a business with in-state and out-of-state receipts shall be allocated (as provided in subsection (b) of this section) or apportioned (as provided in subsection (c) of this section) to Connecticut on a fair and equitable basis in accordance with generally accepted accounting principles. • Once an individual uses either method (allocation or apportionment), he or she shall continue to use that method unless, after application in writing to the Commissioner, the Commissioner determines that the method used no longer reflects income which is fairly attributable to Connecticut.

18. Conn. Agencies Regs. § 12-711(c)-4(b) Books and Records Rule • If the books of the business are kept so as regularly to disclose, to the satisfaction of the Commissioner, the proportion of the net amount of the items of income, gain, loss and deduction derived from or connected with Connecticut sources, the Connecticut nonresident income tax return of the nonresident individual shall disclose the total amount of such items, the net amount of such items allocated to Connecticut, and the basis upon which such allocation is made.

19. Conn. Agencies Regs. § 12-711(c)-4(c) Three-Factor Apportionment • If the books and records of the business do not disclose, to the satisfaction of the Commissioner, the proportion of the net amount of the items of income, gain, loss and deduction attributable to the activities carried on in Connecticut, such proportion shall [except income and gains from real property] be determined by multiplying the net amount of the items of income, gain, loss and deduction of the business by the average of the percentages described in subsections (d) to (f), inclusive, of this section.

20. Three Factors • Property factor -- divide the average values of Connecticut real and tangible property at the beginning and the end of the year by the average beginning and end-of-year values of all property. Conn. Agencies Regs. § 12-711(c)-4(d). • Payroll factor -- divide total wages and compensation paid in respect to services carried on in Connecticut by all wages and compensation. Conn. Agencies Regs. § 12-711(c)-4(e).

21. Three Factors(continued) • Gross income factor -- divide the gross sales or charges for services performed by or through an office, branch, agency or other location of the business within Connecticut, by the total of all gross sales or charges for services performed within and without Connecticut. • The sales or charges to be allocated to Connecticut include all sales negotiated or consummated, and charges for services performed, by an employee, agent, agency or independent contractor chiefly situated at, connected by contract or otherwise with, or sent out from, offices or branches of the business, or other agencies or locations, situated within Connecticut.

22. Contrast With NY Law(Continued) • NY CLS Tax § 631 and 20 NYCRR § 132.15 use language identical to C.G.S. § 711 and Conn. Agencies Regs. § 12-711(c)-4, but NY case law interprets the rules differently: • Statute and regulation disclose “a clear intent that the ‘direct accounting’ method is to be utilized unless the taxpayer’s books do not adequate separate out” the taxpayer’s in-state income. See In the Matter of Piper, Jaffray & Hopwood v. State Tax Commission, 42 A.D. 2d 381 (NY App. Div. 1973).

23. Contrast With NY Law(Continued) • Allocation and apportionment rules applicable to P/Es were intended to follow the rules applicable to corporations under NY’s corporation franchise tax. In the Matter of Thompson v. Mealey, 290 N.Y 230 at 234. (Emphasis added.) “[t]he legislative history, purpose and the express provisions of [current 20 NYCRR § 132.15] indicate that the exaction of the unincorporated business tax is to be imposed only upon net income from business done within this State. The intent of the legislature was to bring unincorporated business enterprises doing business within the State into a tax scheme by which taxes were imposed upon similar businesses conducted within the State by corporations (Legislative Document No. 56, 1935, pp 24, 25) and to make unincorporated businesses share their just proportionate burden of taxation. The Attorney-General admits that the intent was to parallel the corporation franchise tax.”

24. Negative Policy Implications • Taxes in-state P/Es on worldwide sales consummated within the state while allowing non-resident P/Es to make sales to Connecticut purchasers without apportioning ANY income to Connecticut. • Treats Connecticut P/Es inconsistently with Connecticut corporations. • Requires Connecticut P/Es to request specific permission of the Commissioner to change from allocation method to apportionment method. Conn. Agencies Regs. § 12-711(c)-4(a).

25. Some Good News • Voluntary Disclosure for P/Es wishing to “come clean.” • Income Tax audit group -- willing to “make a deal.” • Possible legislative fix?

26. Worker MisclassificationEmployee or Independent Contractor Presented by: Raymond J. Casella, Esq. Shipman & Goodwin LLP 860-251-5808 rcasella@goodwin.com

27. Worker Misclassification Why is the Government Concerned? • Information reporting (W-2 v. 1099) • Tax burden (employer’s share of FICA) • Payroll tax returns (federal and state) • Tax payment timing (weekly v. quarterly) • Non-tax issues: tort laws, labor laws, employment laws, employee benefits, etc. • Noncompliance by independent contractors

28. Worker Misclassification Why is this a Somewhat Complicated Issue in Connecticut? • CT Department of Revenue Services (DRS): Follows the IRS regulations and tests for determining a workers status as an employee or independent contractor. • CT Department of Labor (DOL): Follows its own test referred to as the ABC Test. • The Complication: The tests used by the DRS and the test used by the DOL can yield different results.

29. Worker Misclassification Connecticut Department of Revenue Services Test: • A worker is an employee if the service recipient has the right to control the service provider, not only as to the result to be accomplished, but also as to the details and means by which that result is accomplished. • 20-factor test • Three categories of evidence

30. Instruction Training Integration Services rendered personally Assistants Continuity of relationship Setting of hours Full-time requirement Work location Sequence of work Required reports Payment terms/frequency Travel expenses Furnishing tools Significant investment Profit or loss potential Multiple service recipients Service available to public Worker’s right to terminate Right to discharge The 20 Factors

31. Worker Misclassification Connecticut Department of Labor ABC Test A. The worker is free from control and direction in connection with the performance of such service (the IRS/DRS 20-factor test). • The service is performed outside the usual course of the business for which the service is performed or is performed outside of all the places of business of the enterprise for which such service is performed. • The worker is customarily engaged in an independently established business of the same nature as that involved in the service performed. The ABC test is stated in the conjunctive, all parts must be established in order to prove worker is an independent contractor.

32. Worker Misclassification When it Rains it Pours (a/k/a information sharing)! • Federal/State The IRS and CT DRS share information about employment tax audits and worker misclassification. • State/State The CT DRS and the CT DOL share information about employer audits and worker misclassification (there is also a CT Joint Enforcement Commission on Worker Misclassification). • Federal/Federal September 2011 - US Dept. of Labor and IRS sign agreement to work together to end misclassification.

33. Worker Misclassification What Can You Do? • Perform a self-audit • Substantiation • Consider CT DOL unemployment insurance audit consequences • Consider current CT DRS voluntary disclosure program • Consider IRS Voluntary Classification Settlement Program (VCSP)

34. Worker Misclassification – IRS VCSP • An extremely generous program from the IRS • Significantly reduces tax liability (10% - 1 year) • No interest or penalties • No audit of prior years • VCSP Requirements • Agree to reclassify workers moving forward • Have consistently treated workers as contractors • Be presently treating the workers as contractors • Have filed all required Forms 1099 for last 3 years • Have no classification dispute with IRS over the workers • Not be under audit by IRS, the US DOL or a state agency • Have complied with the classification result of prior IRS audits

35. Successor Liability:Connecticut Income Tax Withholding Prior to July 1, 2011 • Successor Liability for Sales and Use Tax • Successor Liability for Admissions and Dues Tax Effective on or After July 1, 2011 • Successor Liability Also Applies to Connecticut Income Tax Withholding

36. Successor Liability:Connecticut Income Tax Withholding What is Successor Liability? Successor liability is the obligation of the purchaser of a business or stock of goods to withhold a sufficient amount of the purchase price to cover any sales and use tax liability, admissions and dues tax liability, or income tax withholding liability, plus interest and penalties on such liability, owed and unpaid by the seller as of the time of the sale.

37. Successor Liability:Connecticut Income Tax Withholding How Do You Avoid Successor liability? • Request a Tax Clearance Certificate from the DRS. • You will receive back a tax clearance certificate or an escrow letter (or a acknowledgement that your request was not accepted because it didn’t contain all the required information). • If you receive a tax clearance certificate, you are relieved from liability for your business predecessor's tax. • If you receive an escrow letter, you must withhold from the purchase price the amount stated in the escrow letter and pay that amount to the DRS.

38. Successor Liability:Connecticut Income Tax Withholding When Should You Request a Tax Clearance Certificate? • As soon as you can (preferable more than 60 days before the closing). • If you do not know the exact closing date, include in the request the expected closing date. • Once a complete request is received by the DRS, the DRS has 60 days to send a tax clearance certificate or escrow letter. • If the DRS does not send the clearance certificate or escrow letter within 60 days of receipt of all required information, the purchaser is released from successor liability.

39. Responsible Person Liability:Connecticut Income Tax Withholding • What is responsible person liability? • Who is a responsible person? • When is responsible person liability imposed? • IRS also has responsible person liability provisions. 2137059_1