Directors: Do you know where your state taxes are?
True story: Miranda is a director of a large public company that is headquartered on the East Coast. She lives in Massachusetts, but occasionally travels to different cities in her capacity as a board member, primarily to attend meetings. The public company was audited by its home state. The auditor reviewed the company’s travel reimbursements for employees and directors. As a result of the review, the auditor noticed that out-of-town directors were reimbursed for their travel to board meetings in the state. Within a few months, Miranda received a notice from the auditor demanding payment of state taxes on her director’s fees related to the in-state board meetings. Of course, she had already paid tax on those fees to her home state of Massachusetts. Despite privacy laws, Miranda knew that this could get to the media and embarrass the company. She paid up.
Many states are experiencing serious revenue shortfalls, emboldening state tax collection authorities in their search for tax dollars. Miranda’s story is one of a growing many. Some states have been known to go back more than 30 years to assess back taxes on lucrative targets. Directors are not the only targets. Company executives are firmly in the crosshairs as well.
How do you plan for this? What are the rules?
The baseline rule is that an individual is taxed by his home state on his worldwide income. He is also taxed by other states where his income is sourced. Remember that “income” includes not only wages, but stock options, RSUs and even some retirement payments. The tax rules here are a jungle. Consider: you are granted an option when you are a resident of High Tax State. You move to Texas, a state that has no income tax, when the options are deeply in the money, but remain employed. While in Texas you exercise your options, generating federal taxable income but no state tax. Do you owe income taxes to High Tax State? You could indeed.
Now, it is not all bad all the time. For example, if you live in Rhode Island but work in Massachusetts (sometimes known as Taxachusetts), your Massachusetts earnings are taxed by Massachusetts and by Rhode Island. However, if your returns are prepared right, Rhode Island will give you a credit for some or all of the taxes paid to Massachusetts. That way, you pay an effective tax rate equal to the higher of the rates in the two states, but you don’t get taxed twice.
Sounds fair, right? Well, here’s the rub: If you do not report correctly up front, you could end up having tax and penalties in other states with no ability to claim credit in your home state because the statute of limitations has expired.
Directors & Boards EBriefing
Volume 11, Number 3 • March 2014
Read the entire article here.